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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark one)
(X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended December 31, 2003
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ____________to____________
Commission File Number: 001-13343
--------------------------------------------------------------
ADVANTAGE MARKETING SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
Oklahoma 73-1016728
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
711 N.E. 39th Street
Oklahoma City, Oklahoma 73105
(Address of principal executive offices) (Zip code)
REGISTRANT'S TELEPHONE NUMBER INCLUDING AREA CODE: (405) 842-0131
SECURITIES REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT:
Name of each exchange on
Title of each class which registered
------------------- ----------------
Common Stock, $0.0001 Par Value American Stock Exchange
SECURITIES REGISTERED UNDER SECTION 12(g) OF THE EXCHANGE ACT:
Common Stock, $0.0001 Par Value
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes (X) No ( )
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act). Yes ( ) No (X)
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K ( ).
On June 30, 2003, the aggregate market value of the voting and
non-voting common equity held by non-affiliates computed by reference to the
price at which the common equity was last sold, or the average bid and asked
prices of such common equity was $5,612,436.
As of March 19, 2004 there were 6,690,469 shares of Common Stock, par
value $0.0001 per share, outstanding.
Documents incorporated by reference: The information called for by Part
III is incorporated by reference to the definitive proxy statement for the
registrant's 2004 annual meeting of stockholders, which will be filed with the
Securities and Exchange Commission not later than 120 days after December 31,
2003.
ADVANTAGE MARKETING SYSTEMS, INC.
FORM 10-K
For the Fiscal Year Ended December 31, 2003
TABLE OF CONTENTS
Part I.
Item 1. Business..................................................................................................... 3
Item 2. Properties................................................................................................... 19
Item 3. Legal Proceedings............................................................................................ 19
Item 4. Submission of Matters to a Vote of Security Holders.......................................................... 20
Part II.
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity
Securities................................................................................................... 20
Item 6. Selected Financial Data...................................................................................... 21
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation......................... 22
Item 7A. Quantitative and Qualitative Disclosures About Market Risk................................................... 30
Item 8. Financial Statements and Supplementary Data.................................................................. 31
Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure......................... 31
Item 9A. Controls and Procedures...................................................................................... 31
Part III. **
Part IV.
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K.............................................. 32
** Information required by Part III is incorporated by reference from the
Company's definitive proxy statements for its 2004 annual meeting of
shareholders.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
Certain statements under the captions "Item 1. Business," "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operation," and elsewhere in this report constitute "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. Certain, but not
necessarily all, of such forward-looking statements can be identified by the use
of forward-looking terminology such as "anticipates," "believes," "expects,"
"may," "will," or "should" or other variations thereon, or by discussions of
strategies that involve risks and uncertainties. Our actual results or industry
results may be materially different from any future results expressed or implied
by such forward-looking statements. Factors that could cause actual results to
differ materially include general economic and business conditions; our ability
to implement our business and acquisition strategies; changes in the network
marketing industry and changes in consumer preferences; competition;
availability of key personnel; increasing operating costs; unsuccessful
advertising and promotional efforts; changes in brand awareness; acceptance of
new product offerings; changes in, or the failure to comply with, government
regulations (especially food and drug laws and regulations); our ability to
obtain financing for future acquisitions and other factors.
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PART I
ITEM 1. BUSINESS
Advantage Marketing Systems, Inc., or AMS, began operations in 1987,
and through a corporate reorganization in 1995, became an Oklahoma corporation.
We develop and distribute performance-based nutritional, weight loss and
personal care products. We distribute our products through a network marketing
system using independent distributors that we refer to as "associates."
We distribute our products direct to the public through network
marketing. We believe that network marketing is the most effective form of
distribution for products that require additional information. Person-to-person
product education is expensive and not normally available through traditional
distribution channels.
Network marketing appeals to a wide cross-section of people,
particularly those seeking to supplement income, start a home-based business, or
pursue entrepreneurial opportunities other than conventional full-time
employment. We consider the attractive compensation plan, monthly cash bonus
pools, along with trips, prizes and incentives to be attractive components of
the AMS network marketing system.
Our marketing plan is designed to provide financial incentives to
build and manage a team of recruited associates in their downline organization.
On an ongoing basis, we review our product line for duplication and
sales movement and make adjustments accordingly. As of December 31, 2003, our
primary product lines consisted of:
- 34 nutritional products;
- 8 weight management products; and
- 18 personal care products consisting primarily of skin care
products.
Our products are manufactured by various manufacturers pursuant to formulations
developed for us and are sold to our independent associates located in all 50
states, the District of Columbia and Canada.
We believe that our network marketing system is ideally suited to
market nutritional, weight management and personal care products because sales
of such products are strengthened by ongoing personal contact between associates
and their customers. Associates are given the opportunity through sponsored
events and training sessions to network with other associates, develop selling
skills and establish personal goals. We supplement monetary incentives with
other forms of recognition in order to further motivate and foster an atmosphere
of excitement throughout our associate network.
ACQUISITION OF LIFESCIENCE TECHNOLOGIES, INC. ("LST")
Effective January 4, 2001, we purchased the LST group of companies for
$1.2 million and a five-year payment of $41,667 per month or 5% of the gross
sales of LST products, whichever is greater. The seller had the option to take
up to 860,000 shares of common stock in lieu of cash at an option price of $3.00
per share, which was never exercised. As a result of the acquisition, we added
14 products and over 5,000 associates. We paid the remaining balance of the
acquisition cost, plus accrued interest on January 29, 2004.
KEY OPERATING STRENGTHS
Our principal objective is to be a leading developer and distributor of
weight loss products and performance-based wellness systems. Our strategy to
achieve this objective and maintain our position in the industry is to
capitalize on our operating strengths, which include the development and sale of
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performance-based products, a strong product development capability, an
attractive compensation plan for associates, and an experienced management team.
Performance-based Products. We have developed a line of high-quality
health products based on industry demand. We believe that the development and
delivery of essential vitamins, minerals, and other supplements will help
individuals achieve top physical, mental and emotional performance.
Product Development. Our product development effort is based on the
identification of next generation health discoveries, anticipation of consumer
demand and the acquisition of completed and tested new product technology. Our
management team continually:
- Investigates health, performance and industry trends for new
natural extracts and formulated products;
- Searches for formulations and ingredients that may be
candidates for new products;
- Identifies and compares existing and newly identified
nutritional supplements;
- Updates and improves existing products as new discoveries in
nutrition are made; and
- Prepares products to comply with regulatory requirements of
international markets we enter.
Manufacturing. We outsource all manufacturing of our own products for
the following reasons:
- Quality control is easier to monitor at established
facilities;
- The market for quality services in the marketplace is
competitive and attractive; and
- We believe our financial resources are better allocated to
product development, marketing services and sales support.
Attractive Associate Compensation Plan and Benefits. We are committed
to providing a highly competitive compensation plan to attract and retain
associates, who constitute our sales force. We believe the AMS associate
compensation plan is one of the most financially rewarding in the network
marketing industry. We pay daily incentives for recruiting new associates and
weekly commissions for product sales. The AMS compensation plan is a consistent
plan, meaning associates can recruit and receive compensation daily and weekly
for their business in any market in which we conduct business. To drive sales,
plus provide product information and team management skills for associates, we
sponsor events throughout the year which offer information about our products
and the network marketing system. These meetings are designed to assist new
associates with business development and provide a forum for product
development, in addition to providing interaction with successful associates and
our management.
Experienced Management Team. Our management team includes individuals
with expertise in various managerial disciplines, including marketing, customer
service, information technology, finance and operations. The current executive
management team is responsible for developing an infrastructure to support rapid
growth, strengthening our financial condition, and improving operational
controls.
GROWTH STRATEGY
We seek to grow our business by pursuing the following strategies:
New Associate and Preferred Customer Recruiting, Training and
Development. We recognize the need to aggressively grow our associate sales
force, thereby building new sales. In 2003, we re-launched the Company to the
industry after restructuring the marketing, sales and internet business
strategies. We focused on the development and distribution of performance-based
nutrition and weight loss products that will allow consumers to see and feel the
difference, and others to noticeably recognize the difference in them within a
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short period of time. We recognize the value that repositioning offers, backed
by our exclusive core products: AM-300, Prime One, Prime One Concentrate and
ToppFast.
With new product packaging, new leadership and an enhanced commission
plan for recruiting, we are focused on building the associate customer base and
assisting associates in building their businesses and have declared 2004 "The
Year of Recruiting". This focus includes the introduction of a monthly cash
bonus pool targeted at new associate recruiting, the establishment of two, 24
hour-a-day, seven day-a-week Internet sites and weekly hotel opportunity
meetings intended to present the business opportunity to potential associates.
During 2003, we focused on associate recruiting by introducing two Internet
marketing systems, with training approved and supported by the Company. We
launched a cutting edge recruiting and product selling website for associates as
well as an advanced lead generation and recruiting marketing site that allows
associates to market online for new customers and associates.
As a result of this focus, we are positioned to increase associate
enrollments in fiscal year 2004. In an effort to aggressively attract and retain
associates, we intend to continue to introduce new performance-based products
that deliver noticeable results, to enhance the compensation plan, to introduce
Internet marketing, to introduce duplicatable sales tools, to expand weekly
meetings and to enhance infrastructure to promote customer service levels.
New Market Entry. We believe that, in addition to the U.S. and Canadian
markets, significant growth opportunities continue to exist in international
markets. We intend to select new markets following an assessment of several
factors including market size, anticipated demand for AMS products, receptivity
to network marketing, and ease of entry, which includes consideration of
possible regulatory restrictions on our products or network marketing system. We
will begin preparation for further international expansion as sales leadership
develops. We envision a seamlessly integrated associate compensation plan in
each market that allows associates to receive commissions for global sales. This
seamless downline (associate's sales organization, including the associate's
recruits and their recruits) structure would be designed to allow an associate
to build a global network by creating downlines across national borders.
Associates would not be required to establish new downlines or to re-qualify for
higher levels of compensation in newly opened markets. We believe that going to
a seamless compensation plan provides significant motivation and reward for
associates to expand internationally by entering these new markets.
New Product Introduction. Using our marketing demand and development
capabilities, we will continue to introduce new products and continuously
enhance existing products. Products introduced in 2003 include AM-300 Fat
Burning Solution, Spark of Life -daily liquid nutritional, Topp Fast meal
replacement shakes, Prime Plus anti-catabolic lean muscle enhancer, Vital
Chelates Plus, The Sorgente Trio Non-Surgical facelift and Coral Calcium. Our
practice is to introduce new products, primarily at Company-sponsored events,
based on demand.
Strategic Acquisitions. We believe that attractive acquisition
opportunities may arise in the future. We intend to pursue strategic acquisition
opportunities that would grow our customer base, expand product lines, enhance
manufacturing and technical expertise, allow vertical integration, or otherwise
complement our business or further our strategic goals.
INDUSTRY OVERVIEW
The nutrition industry includes many small- and medium-sized companies
that manufacture and distribute products generally intended to maintain the
body's health and general well being. The four major product categories within
the nutrition industry are as follows:
- Nutritional Supplements - products such as vitamins and
minerals, sports performance enhancers, meal replacements,
dietary supplements, herbs and botanicals, and compounds
derived from these substances;
- Natural and Organic Foods - products such as cereals, milk,
non-dairy beverages, and frozen entrees;
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- Functional Foods - products with added ingredients or
fortification specifically for health or performance
purposes; and
- Natural Personal Care - products combining nutrition with
skin care.
We believe that the nutrition industry is being fueled by the
following:
- The public's exposure to more widely accepted natural and
homeopathic alternatives;
- The desire to slow down the aging process;
- The national and worldwide trend toward preventive health
care combining Eastern and Western medicine; and
- The rapid product introductions taking place in response to
scientific research fueled by new demand.
Nutritional products are distributed through six major sales channels.
Each channel has changed in recent years, primarily due to advances in
technology and communications, resulting in improved product distribution and
faster dissemination of information. The major sales channels are as follows
(AMS associates participate in four of the six channels listed below):
- Mass market retailers, including mass merchandisers, drug
stores, supermarkets and discount stores;
- Natural health food retailers;
- Network marketing;
- Mail order;
- Healthcare professionals and practitioners; and
- The Internet.
PRODUCTS
Our primary product lines include nutritional, weight management and
personal care. We currently market approximately sixty products, exclusive of
variations in product size, colors or similar variations of our basic product
line.
Nutritional. This product line includes antioxidants, minerals,
vitamins, and other nutritional supplements. The nutritional supplement products
are designed to provide optimal absorption, bioavailability, and efficacy.
During the years ended December 31, 2003, 2002 and 2001, 44.9%, 40.2% and 38.9%
of our net sales were derived from the 34 products in the nutritional category,
which contain herbs, vitamins, minerals and other natural ingredients. The
top-selling products in this category are Prime One, Prime One Concentrate and
Spark of Life liquid nutritional which totaled approximately 16.0%, 3.8% and
4.3%, respectively, of net sales in fiscal year 2003.
Weight Management. This product line was developed to provide a
comprehensive approach to weight management including the AM-300 family of
weight loss supplements, along with weight loss systems. During the years ended
December 31, 2003, 2002 and 2001, the weight management category represented
48.0%, 51.8% and 54.7% of our net sales. Sales were derived from the eight
products in the weight management category that we market under the Advantage
Marketing Systems label.
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Personal Care. This product line includes scientifically developed
natural products designed to support healthy skin and hair. Products in this
line include those from the Chambre International line and products acquired
from Dr. Robert Nakamura and Immudyne Inc. The three-product wrinkle and
facial-line reducing system is called "Nino Sorgente Skin Care" and includes eye
serum, facial serum and daily moisturizer. During the years ended December 31,
2003, 2002 and 2001, 2.8%, 2.9% and 1.5% of our net sales were derived from the
18 products in the personal care category.
Promotional Materials. In addition to these three principal product
lines, we have developed and sell to associates materials and online tools
designed to assist them in building their business and selling products. These
sales aids are generally written and produced by AMS and include product audio
tapes, CD ROM'S, video tapes, brochures and business forms designed by us and
printed by outside publishers. We periodically contract with authors and
publishers to produce or provide books, tapes, and other items dealing with
health topics and personal motivation, which are made available to associates.
New associates are required to purchase an enrollment packet containing
training materials that assist in beginning and growing a business. Associates
do not earn commissions on the sale of sales aids or enrollment packets.
Other Products and Services. Prior to focusing on nutritional, weight
management and personal care products in October 1993, we marketed various
packages of consumer benefit services provided by third-party providers. The
only remaining benefit service we offer is a pre-paid legal service. The
pre-paid legal services are provided by Pre-Paid Legal Services, Inc. This
program membership represented less than 1% of our net sales during 2003, 2002
and 2001.
New Product Identification. We are committed to continuous product
innovation and improvement through market demand and products backed by science.
The mission of our science and product development is to develop, for target
groups, advanced wellness products that deliver performance-based results around
our core peak performance and weight loss focus. That is, products that deliver
noticeable results, slow the aging process, reduce the risk of chronic illness,
and promote long-term health. New product ideas and research efforts are
supported using a combination of our advisory talent and research, third-party
studies and sponsored research. We intend to dedicate resources for the science
and development of new products and reformulation of existing products. Prior to
introducing new products, we investigate product formulation as it relates to
regulatory compliance and other issues.
For products on which we acquire the distribution or ownership rights,
we maintain and access any and all science and research related to those
products. For example, the acquisition of Prime One brought over 45 years of
research and thousands of trials and studies on the Prime One products and
ingredients. The distribution rights for Immudyne's Sorgente skin care system
brought the use of patents, studies and documentation for use in our marketing
effort.
We maintain an advisory relationship with Dr. Robert Nakamura, and also
rely upon the product development staff of Chemins Company, Inc. and other
manufacturers, independent researchers, vendor research departments and others
for such services. When a new product concept is identified or when an existing
product must be reformulated, the new product concept or reformulation project
is generally submitted to Chemins for technical development and implementation.
We continually review our existing products for potential enhancements to
improve their effectiveness and marketability. While we consider our product
formulations to be proprietary trade secrets, such formulations are not
patented. Accordingly, there is no assurance that another company will not
replicate one or more of our products.
Product Procurement and Distribution; Insurance. Essentially all of our
product line in the weight management category is manufactured by Chemins
Company, Inc. utilizing our product formulations. Naturtech manufactures our
nutritional product line, and essentially all of our product line in the
personal care category is manufactured by GDMI, Inc. and Columbia Cosmetics,
Inc.
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All our vendors have assured us that they conduct quality control
processes, and laboratory analysts test for biological contamination of raw
materials and finished goods. In the analytical chemistry laboratory, analysts
test for chemical contamination and accurate active ingredient levels of raw
materials and finished products. Both laboratories conduct stability tests on
finished products to determine product shelf life.
We have not generally entered into long-term supply agreements with the
manufacturers of our product line or the third-party providers of our consumer
benefit services. However, we customarily enter into contracts with our
manufacturers and suppliers to establish the terms and conditions of purchases.
Our arrangements with Chemins Company, Inc. may be terminated by either party
upon the completion of any outstanding purchase orders. Therefore, there can be
no assurance that Chemins will continue to manufacture our products or provide
research, development and formulation services. In the event the relationship
with any of our manufacturers becomes impaired, we will be required to obtain
alternative manufacturing sources for our products. In such event, there is no
assurance that the manufacturing processes of our current manufacturers can be
replicated by another manufacturer. Although we have not previously experienced
product unavailability or supply interruptions, we believe that we would be able
to obtain alternative sources for our nutritional, weight management and
personal care products. A significant delay or reduction in availability of
products, however, could have a material adverse effect on our business,
operating results and financial condition.
Most of the raw materials used in the manufacture of our products are
available from a number of suppliers. We have not generally experienced
difficulty in obtaining necessary quantities of raw materials. When supplies of
certain raw materials have tightened, we have been able to find alternative
sources as needed, and believe we will be able to do so in the future if the
need arises.
We, like other marketers of products that are intended to be ingested,
face an inherent risk of exposure to product liability claims in the event that
the use of our products results in injury. We maintain a claims made policy,
with limited product liability insurance with coverage limits of $1,000,000 per
occurrence and $2,000,000 in the aggregate. Products containing ephedra, which
represented 35.9% of our 2003 net sales, are not covered by our product
liability insurance. Although we do not obtain contractual indemnification, our
product manufacturers carry product liability insurance that covers our
products. Product liability claims in excess of insurance coverage may result in
significant losses, which would adversely affect product sales, results of our
operations, financial condition and the value of our common stock.
All of the items in our product line include a customer satisfaction
guarantee. Within 30 days of purchase, any retail customer or associate who is
not satisfied with our product for any reason may return it or any unused
portion to the associate from whom it was purchased or to us for a full refund
or credit toward the purchase of another product. Associates may obtain
replacements from us for products returned to them by retail customers if they
return such products on a timely basis. Furthermore, in most jurisdictions, we
maintain a buy-back program. Under this program, we will repurchase products
sold to an associate, subject to a 10% restocking charge, provided the associate
resigns and returns the product in marketable condition within 12 months of
original purchase, or longer where required by applicable state law or
regulations. We believe this buy-back program addresses a number of the
regulatory compliance issues pertaining to network marketing systems. For the
years ended December 31, 2003, 2002 and 2001, the cost of products returned to
us was 0.9%, 0.6% and 1% of gross sales.
Our product line is distributed principally from our facilities in
Oklahoma City or from our regional support centers. Products are warehoused in
Oklahoma City and at selected regional support centers.
NETWORK MARKETING
We market and distribute our products through a network marketing
system and sell directly to associates and preferred customers. At December 31,
2003, we had approximately 18,552 "active" associates. To be considered "active"
an associate must have purchased $50 in products or $22 on autoship of our
products within the preceding 90 days. Network marketing is a form of
person-to-person direct selling through a network of vertically organized
independent distributors who purchase products at wholesale prices from the
manufacturer for resale to retail consumers. The emergence of readily available
means of mass communication such as personal computers, facsimiles, low-cost
long distance telephone services, and the Internet have
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contributed to the rapid growth of network marketing. The concept of network
marketing is based on the strength of personal recommendations that frequently
come from friends, neighbors, relatives, and close acquaintances. We believe
that network marketing is an effective way to distribute our products because it
allows person-to-person product education, which is not as readily available
through other distribution channels. We believe our network marketing system
appeals to a broad cross-section of people, particularly those seeking to:
- Supplement family income;
- Start a home business; or
- Pursue employment opportunities other than conventional, full-time
employment.
A majority of our associates therefore sell our products on a part-time basis.
We believe that our network marketing system is ideally suited to
market our product line because sales of such products are strengthened by
ongoing personal contact between retail consumers and associates, many of whom
use our products themselves. Sales are made through direct personal sales
presentations as well as presentations made to groups in a format known as
"opportunity meetings." These sales methods are designed to encourage
individuals to purchase our products by informing potential customers and
associates of our product line and results of personal use, and the potential
financial benefits of becoming an associate. The objective of the marketing
program is to develop a broad based network marketing organization within a
relatively short period. Our marketing efforts are typically focused on
middle-income families and individuals.
Our network marketing program encourages individuals to develop their
own downline network marketing organizations. Each new associate is either
linked to:
- The existing associate that personally enrolled the new associate into
our network marketing organization; or
- The existing associate in the enrolling associate's downline as
specified at the time of enrollment.
Growth of an associate's downline organization is dependent on the recruiting
and enrollment of additional associates within such associate's downline
organization.
Associates are encouraged to assume responsibility for training and
motivation of others within their downline organization and to conduct
opportunity meetings as soon as they are appropriately trained. We strive to
maintain a high level of motivation, morale, enthusiasm and integrity among the
members of our network marketing organization. We believe this result is
achieved through a combination of products, sales incentives, personal
recognition of outstanding achievement and quality promotional materials. Under
our network marketing program, associates purchase sales aids and brochures from
us and assume the costs of advertising and marketing our product line to their
customers as well as the direct cost of recruiting new associates. We believe
that this form of sales organization is cost efficient because our direct sales
expenses are primarily limited to the payment of bonuses, which are only
incurred when products are sold.
We continually strive to improve our marketing strategies, including
the compensation structure within our network marketing organization and the
variety and mix of products in our line, to attract and motivate associates.
These efforts are designed to increase monthly product sales and the recruiting
of new associates.
To aid associates in easily meeting the monthly personal product
purchase requirement to qualify for bonuses, we developed the "autoship" in
1994. Under the autoship purchasing arrangement, associates establish a standing
product order for an amount in excess of $22 that is automatically charged to
their credit card or deducted from their bank account for goods shipped that
month. At December 31, 2003, 2002, and 2001, we had approximately 16,343,
23,051, and 27,912 associates participating in the autoship.
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Our bonus structure provides for payment of bonuses on product
purchases made by other associates in an associate's downline organization.
Associates derive income from several sources:
- First, associates earn profits by purchasing from our product line at
wholesale prices (which are discounted up to 40% from suggested retail
prices) and selling to customers at retail;
- Second, associates earn profits from the products sold in the sign-up
of new associates from our enroller bonuses and lucrative coding
bonuses, which are tied to the downline organization;
- Third, associates who establish their own downline organization may
earn bonuses of up to 36% of bonus value on product purchases by
associates within the first four levels of their downline organization;
- Fourth, associates who have $600 per month of product purchases on
their first and second levels combined, become directors and have the
opportunity to build an additional director downline organization and
receive additional bonuses of 4% of bonus value on product purchases by
such downline organization;
- Fifth, associates who have $1,200 per month of product purchases on
their first and second levels combined, two director legs and $2,500
wholesale volume monthly in their downline, become silver directors and
have the opportunity to build an additional silver director downline
organization and receive additional bonuses of 5% of bonus value on
product purchases by such downline organization;
- Sixth, associates who have $1,800 per month of product purchases on
their first level and second levels combined, two silver legs and have
a total of $5,000 wholesale volume monthly in their downline, become
gold directors and have the opportunity to receive an additional bonus
of 3% of bonus value on product purchases by their silver director
downline organization. In addition, gold directors have the opportunity
to receive generation bonuses of up to 3% of bonus value on the product
purchases by associates of silver director downline organizations that
originate from their silver director downline organization through four
generations; and
- Seventh, associates who maintain the gold director requirements and
develop three gold directors, each one from a separate leg of their
downline organization plus $40,000 wholesale volume in downline
organization, become platinum directors and have the opportunity to
build an additional platinum director downline organization and receive
additional bonuses of 5% of bonus value on product purchases by such
downline organization.
Combining these levels of bonuses, our total "pay-out" on products
subject to bonuses is approximately 63% of the bonus value of product sales, and
42.1% of total sales.
Each associate in our network marketing organization has a director, a
silver director, a gold director and a platinum director. Each director has a
silver director, a gold director and a platinum director. Each silver director
has a gold director and a platinum director. Each gold director has a platinum
director. As of December 31, 2003, we had 295 silver directors, 393 gold
directors and 50 platinum directors.
Under our regional support center program, we designate associates to
serve as regional support center directors and provide them special training and
support. Each regional support center director functions as a product
distribution center for our products. As of December 31, 2003, we had 38
regional support center directors.
We maintain a computerized system for processing associate
orders and calculating bonus payments which enable us to remit such payments
promptly. We believe that prompt and accurate remittance of bonuses is vital to
recruiting and maintaining associates, as well as increasing their motivation
and loyalty to us. We make weekly bonus payments based upon the previous week's
product purchases, while most network marketing companies only make monthly
bonus payments. During 2003, 2002 and 2001, we paid bonuses to 6,824, 8,909 and
11,814 associates, in the aggregate amounts of $7,504,420, $9,414,421 and
$11,403,519, respectively.
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We are committed to providing the best possible support to our
associates. Associates in our network marketing organization are provided
training guides and are given the opportunity to participate in our training
programs. We sponsor regularly scheduled conference calls for our platinum
directors which include testimonials from successful associates and satisfied
customers as well as current product and promotional information. We produce a
monthly newsletter which provides information on our products and network
marketing system. The newsletter is designed to help recruit new associates by
answering commonly asked questions and includes product information and business
building information. The newsletter also provides a forum for additional
recognition of associates for outstanding performance. In addition, we regularly
sponsor training sessions for our associates across the United States. At these
training sessions, associates are provided the opportunity to learn more about
our product line and selling techniques so they can build their businesses more
rapidly. We produce comprehensive and attractive four color catalogues and
brochures that display and describe our product line. We maintain a web page at
www.amsonline.com, which provides general company information along with product
line and network marketing system information.
From time to time, associates fail to adhere to the AMS policies and
procedures, including those governing the marketing of our products or
representations regarding the compensation plan. We systematically review
reports of alleged associate misbehavior. Infractions of the policies and
procedures are reported to a compliance committee that determines what
disciplinary action may be warranted in each case. If we determine that an
associate has violated any of the AMS policies and procedures, we may take a
number of disciplinary actions. For example, we may terminate the associate's
purchase and distribution rights completely, or impose sanctions such as
warnings, fines, or probation. We may also withdraw or deny awards, suspend
privileges, withhold commissions until specific conditions are satisfied, or
take other appropriate actions at our discretion. An in-house compliance
department also routinely reviews associate activities.
We believe that the ability to efficiently manage distribution,
compensation, manufacturing, inventory control, and communications functions
through the use of sophisticated and dependable information processing systems
is critical to our success. To optimally support our customer base and core
business processes, our information technology resources consist of a
customized, Web-enabled order-entry system and an integrated system to manage
inventory, production planning, fulfillment, and financial information. Our
information systems are maintained by in-house staff and outside consultants.
These systems are designed to provide, among other things, financial and
operating data for management, timely and accurate product ordering, bonus
payment processing, inventory management and detailed associate records. Since
1994, we have invested more than $2,700,000 to enhance our computer and
telecommunications systems.
REGULATION
In the United States, as well as in any foreign markets in which we may
sell our products, we are subject to laws, regulations, administrative
determinations, court decisions and similar restrictions at the federal, state
and local levels, collectively known as "regulations". These regulations include
and pertain to, among other things:
- The formulation, manufacturing, packaging, labeling, advertising,
distribution, importation, sale and storage of our products;
- Our product claims and advertising, including direct claims and
advertising as well as claims and advertising by associates, for which
we may be held responsible; and
- Our network marketing organization.
Products. The formulation, manufacturing, packaging, labeling,
advertising, distribution and sale and storage of our products are subject to
regulation by a number of governmental agencies. The federal agencies include
the Food and Drug Administration, or FDA, the Federal Trade Commission, or FTC,
the Consumer Product Safety Commission, the United States Department of
Agriculture and the Environmental
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Protection Agency. Our activities are also regulated by various codes and
agencies of the states, localities and foreign countries in which our products
are or may be manufactured, distributed or sold. The FDA, in particular,
regulates the formulation, manufacturing and labeling of dietary supplements,
cosmetics and skin care products, including some of our products.
The Dietary Supplement Health and Education Act of 1994, or DSHEA,
revised the provisions of the Federal Food, Drug and Cosmetic Act, or FFDCA,
concerning the composition and labeling of dietary supplements, which we believe
is generally favorable to the dietary supplement industry. DSHEA created a new
statutory category of products, or "dietary supplements." This new category
includes vitamins, minerals, herbs, amino acids and other dietary substances for
human use to supplement the diet. However, DSHEA grandfathered, with certain
limitations, dietary ingredients that were on the market before October 15,
1994. A dietary supplement containing a new dietary ingredient and placed on the
market on or after October 15, 1994 must have a history of use or other evidence
establishing a basis for expected safety. Manufacturers of dietary supplements
using a "structure-function" statement or claim must have substantiation that
the statement is truthful and not misleading.
The majority of our sales come from products that are classified as
dietary supplements under the FFDCA and DSHEA. The labeling requirements for
dietary supplements have been set forth in final regulations, with respect to
labels affixed to containers, effective March 23, 1999. These regulations
include how to declare nutrient content information, and the proper detail and
format required for the "Supplement Facts" box. During 1999, we revised our
product labels to be in compliance with these regulations. Many states have also
recently become active in the regulation of dietary supplement products. These
states may require modification of labeling or formulation of certain of our
products sold in these states, e.g. Texas and California.
In addition, on January 6, 2000, the FDA published a Final Rule on
permissible structure/function statements to be placed on labels and in
brochures. Structure/function statements are claims of the benefit or positive
effect of a product or an ingredient on the body's structure or function. This
regulation does not significantly change the way that the FDA interprets
structure/function statements. Thus, we did not make any substantial label
revisions based on this regulation regarding any of our structure/function
product statements. We believe that AMS has adequate substantiation for all
label claims used.
Ehpedra. As a marketer of products that are ingested by consumers, we
are subject to the risk that one or more of the ingredients in our products may
become the subject of adverse regulatory action. For example, one of the
ingredients in our AM-300 product is Ephedra, an herb that contains
naturally-occurring ephedrine alkaloids. Our manufacturer uses a powdered
extract of that herb when manufacturing AM-300. We market AM-300 principally as
an aid in weight management. The extract is an 8% extract, which means that
every 100 milligrams of the powdered extract contains approximately eight
milligrams of naturally occurring ephedrine alkaloids. Ephedrine-containing
dietary supplements have been the subject of adverse publicity in the United
States and other countries relating to alleged harmful effects, or adverse
events.
On February 11, 2004, the FDA issued and published in the Federal
Register its Final Rule on Ephedrine-containing Supplements, stating that since
an "unreasonable risk" had been determined, such supplements would be considered
"adulterated" under the FFDCA, and thus may not be sold. In essence, this Final
Rule (or regulation) imposes a national ban on ephedrine supplements.
The effective date of this regulation is April 12, 2004. The Company
will comply with the new regulation and cease all sales and advertisement of
AM-300 and any other ephedra-containing supplement on April 12, 2004.
Anticipating the eventuality of a total ban, over a year ago AMS formulated an
Ephedra-free AM-300 for weight loss. After April 12, 2004, this non-ephedra
product will still be permitted, and we expect strong sales. For the future, the
FDA has indicated that it will now consider whether alternatives to Ephedra,
other weight loss and energy stimulants (such as bitter orange) similarly carry
an unreasonable risk. These proposals to limit stimulant ingredients, if
finalized, may necessitate reformulations of some of our weight loss products.
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Finally, as the press, the FDA, and members of Congress and of the
supplement industry have all predicted, the very issuance of the Final Rule on
Ephedra may cause Congress to rethink and amend DSHEA as to how safety in
supplements may be ensured. In particular, there is growing sentiment (including
from one herbal trade association) to make Adverse Event Reporting mandatory for
all manufacturers and marketers of dietary supplements, so that FDA may take
action more quickly than it did on Ephedra, when a harmful herb or other
ingredient is suspected.
The Texas Department of Health promulgated a new regulation, which
became effective on January 1, 2001. The regulation requires a warning to appear
on the product label indicating that the sale of ephedra-containing products to
minors is illegal. Our AM-300 labels comply with this regulation. Again, after
April 12, 2004, no sales of ephedrine-containing supplements are allowed
nationally, and thus state regulations such as this are superceded and moot.
Manufacturing. On March 13, 2003, the FDA published a proposed rule in
the Federal Register which proposes comprehensive requirements for the
manufacturing, packing and holding dietary supplements, also known as good
manufacturing practices, or GMPs. The FDA accepted public comments on the
proposed GMPs until June 11, 2003; final GMPs will be promulgated after the FDA
has reviewed the public comments. Once final GMP regulations become effective,
our manufacturer will be required to adhere to them. The FDA will most likely
institute an effective date for the GMPs which will allow our manufacturer a
reasonable amount of time to conduct this review and, if necessary, revise its
manufacturing operations to comply with the final GMP regulations.
Advertising and Website. The FDA considers website promotional content
to constitute "labeling," and thus the AMS website must not contain disease
claims or drug claims, but only permissible structure/function claims. The FTC
governs the advertising of dietary supplements, in any medium or vehicle--print
ads, radio spots, infomercials, etc.--including on Internet ads and websites.
The fundamental FTC rule is that all material advertising claim, whether express
(direct) or implied, must be substantiated by reliable and competent scientific
evidence. Because our website must comply with both FDA and FTC regulations, we
routinely ask our regulatory compliance counsel to review certain web pages,
especially the content of new product promotions. When necessary, our regulatory
counsel also reviews the scientific substantiation for particular claims (again,
especially for new products such as Prime One, an anti-stress and weight loss
product) to determine if it is sufficient, and also that there are no disease
claims present, the main FDA issue. AMS also requires associate websites to be
in compliance with FDA and FTC regulations. As such, and to ensure Internet
compliance, associates may only copy or link to our corporate website. Any
independent websites are absolutely unauthorized, and their creators are solely
liable for defending any regulatory enforcement actions.
In markets outside the United States, prior to commencing operations or
marketing products, we may be required to obtain approvals, licenses, or
certifications from a country's ministry of health or comparable agency.
Approvals or licensing may be conditioned on reformulation of AMS products for
the market or may be unavailable with respect to certain products or product
ingredients. We must also comply with local product labeling and packaging
regulations that vary from country to country. Foreign regulatory requirements
have not placed a significant burden on our ability to operate in current
foreign countries.
Product Claims and Advertising. Advertising of products is subject to
regulation by the FTC under the FTC Act. Section 5 of the FTC Act prohibits
unfair methods of competition and unfair or deceptive acts or practices in or
affecting commerce. Section 12 of the FTC Act provides that the dissemination
of, or causing to be disseminated, any false advertisement pertaining to drugs
or foods, which would include dietary supplements, is an unfair or deceptive act
or practice. Under the FTC's Substantiation Doctrine, an advertiser is required
to have a "reasonable basis" for all objective product claims before the claims
are made. Failure to adequately substantiate claims may be considered either
deceptive or unfair practices. Pursuant to this FTC requirement, we are required
to have adequate substantiation for all material advertising claims made for our
products.
In recent years the FTC has initiated numerous investigations of and
actions against dietary supplement, weight management, and cosmetic products and
companies. The FTC has issued a guidance
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document to assist companies in understanding and complying with the
substantiation requirement. We have organized the documentation to support our
advertising and promotional practices in compliance with these guidelines.
The FTC may enforce compliance with the law in a variety of ways, both
administratively and judicially, using compulsory process, cease and desist
orders, and injunctions. FTC enforcement can result in orders requiring, among
other things, limits on advertising, corrective advertising, consumer redress,
divestiture of assets, rescission of contracts, and such other relief as the
agency deems necessary to protect the public. Violation of these orders could
result in substantial financial or other penalties. We have not been notified
that we were the subject of any action by the FTC, but any action in the future
by the FTC could materially adversely affect our ability to successfully market
our products.
Compliance Efforts. We attempt to remain in full compliance with all
applicable laws and regulations governing the manufacture, labeling, sale,
distribution, and advertising of our dietary supplements. We retain special
legal counsel for advice on both Food and Drug Administration and Federal Trade
Commission legal issues. In particular, we work closely with special legal
counsel who specializes in Dietary Supplement Health and Education Act
regulations for label revisions, content of structure/function statements,
advertising copy, and also the position of the Food and Drug Administration on
ephedra-containing products.
Network Marketing System. Laws and regulations in each country in which
we operate prevent the use of deceptive or fraudulent practices that have
sometimes been inappropriately associated with legitimate direct selling and
network marketing activities. These laws include anti-pyramiding, securities,
lottery, referral selling, anti-fraud and business opportunity statutes,
regulations, and court cases. Illegal schemes, typically referred to as
"pyramid," "chain distribution," or "endless chain" schemes, compensate
participants primarily or solely for the introduction or enrollment of
additional participants into the scheme. Often these schemes are characterized
by large up-front entry or sign-up fees, over-priced products of low value,
little or no emphasis on the sale or use of products, high-pressure recruiting
tactics, and claims of huge and quick financial rewards requiring little or no
effort. Generally these laws are directed at ensuring that product sales
ultimately are made to consumers and that advancement within sales organizations
is based on sales of the enterprise's products, rather than investments in the
organizations or other non-retail sales related criteria or activity. Where
required by law, we obtain regulatory approval of our network marketing system,
or, where approval is not required or available, the favorable opinion of local
counsel as to regulatory compliance.
We currently have independent associates in all 50 states, the District
of Columbia, and Canada. In addition to federal regulation in the United States,
each state has enacted its own "Little FTC Act" to regulate sales and
advertising. Occasionally we receive requests to supply information regarding
our network marketing plan to regulatory agencies. Although we have from time to
time modified our network marketing system to comply with interpretations of
various regulatory authorities, we believe that our network marketing program is
in compliance with laws and regulations relating to network marketing activities
in our current markets. Nevertheless, we remain subject to the risk that, in one
or more of our present or future markets, the marketing system or the conduct of
certain associates could be found not to be in compliance with applicable laws
and regulations. Failure by an associate or us to comply with these laws and
regulations could have a material adverse effect on our business in a particular
market or in general. Any or all of these factors could adversely affect the way
we do business and could affect our ability to attract potential associates or
enter new markets. In the United States, the FTC has been active in its
enforcement efforts against both pyramid schemes and legitimate network
marketing organizations with certain legally problematic components, having
instituted several enforcement actions resulting in signed settlement agreements
and payment of large fines. Although to our knowledge, we have not been the
target of an FTC investigation, there can be no assurance that the FTC will not
investigate us in the future. Noncompliance with applicable laws and regulations
could:
- Result in enforcement action and imposition of penalties;
- Require modification of our network marketing system;
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- Result in negative publicity; or
- Have a negative effect on associate morale and loyalty.
Any of these consequences could have a material adverse effect on our sales as
well as our financial condition.
We cannot predict the nature of any future law, regulation,
interpretation, or application, nor can we predict what effect additional
governmental legislation or regulations, judicial decisions, or administrative
orders, when and if promulgated, would have on our business in the future. It is
possible that future developments may require that we revise our network
marketing program. Any or all of these requirements could have a material
adverse effect on our business, results of operations, and financial condition.
We are subject to the risk of challenges to the legality of our network
marketing system by our associates, both individually and as a class. Generally
such challenges would be based on claims that our network marketing system was
operated as an illegal "pyramid scheme" in violation of federal securities laws,
state unfair practice and fraud laws and the Racketeer Influenced and Corrupt
Organizations Act.
Two important Federal Trade Commission cases have established legal
precedent for determining whether a network marketing system constitutes an
illegal pyramid scheme. The first, IN RE KOSCOT INTERPLANETARY, INC., 86 F.T.C.
1106 (1975), set forth a standard for determining whether a marketing system
constituted a pyramid scheme. Under the KOSCOT standard, a pyramid scheme is
characterized by the participants' payment of money to a company in return for:
- The right to sell a product; and
- The right to receive, in return for recruiting other participants into
the program, rewards that are unrelated to sales of the product to
ultimate users.
Applying the KOSCOT standard in IN RE AMWAY CORP., 93 F.T.C. 618 (1979), the
Federal Trade Commission determined that a company will not be classified as
operating a pyramid scheme if the company adopts and enforces policies that in
fact encourage retail sales to consumers and prevent "inventory loading".
Inventory loading occurs when associates purchase large quantities of
non-returnable inventory to obtain the full amount of compensation available
under the system. In AMWAY, the Federal Trade Commission found that the
marketing system of Amway Corporation did not constitute a pyramid scheme,
noting the following Amway policies:
- Participants were required to buy back, from any person they recruited,
any saleable, unsold inventory upon the recruit leaving Amway;
- Every participant was required to sell at wholesale or retail at least
70% of the products bought in a given month in order to receive a bonus
for that month; and
- In order to receive a bonus in a month, each participant was required
to submit proof of retail sales made to 10 different consumers.
We believe that our network marketing system is not classified as a
pyramid scheme under the standards set forth in KOSCOT, AMWAY, and other
applicable law. In particular, in most jurisdictions, we maintain an inventory
buy-back program to address the problem of inventory loading. Pursuant to this
program, we repurchase products sold to an associate (subject to a 10%
restocking charge) provided that the associate:
- Resigns; and
- Returns the product in marketable condition within 12 months of
original purchase, or longer where required by applicable state law or
regulations.
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Our literature provided to associates describes our buy-back program. In
addition, pursuant to agreements with our associates, each associate represents
that at least 70% of the products he or she buys will be sold to non-associates.
However, as is the case with other network marketing companies, the bonuses paid
by us to our associates are based on product purchases including purchases of
products that are personally consumed by the downline associates. Basing bonuses
on sales of personally consumed products may be considered an inventory loading
purchase. Furthermore, associates' bonuses are based on the wholesale prices
received by us on product purchases or, in some cases based upon the particular
product purchased, on prices less than the wholesale prices.
In the event of challenges to the legality of our network marketing
system by associates, we would be required to:
- Demonstrate that our network marketing policies are enforced; and
- That the network marketing system and associates' compensation
thereunder serve as safeguards to deter inventory loading and encourage
retail sales to the ultimate consumers.
In WEBSTER V. OMNITRITION INTERNATIONAL, INC., 79 F.3d 776 (9th Cir.
1996), the United States Court of Appeals held that a class action brought
against Omnitrition International, Inc., a multilevel marketing seller of
nutritional supplements and skin care products, should be allowed to proceed to
trial. The plaintiffs, former associates of Omnitrition's products, alleged that
Omnitrition's selling program was an illegal pyramid scheme and claimed
violations of Racketeer Influenced and Corrupt Organizations Act and several
federal and state fraud and securities laws. Despite evidence that Omnitrition
complied with the AMWAY standards, the court ruled that a jury would have to
decide whether Omnitrition's policies, many of which apparently were similar to
compliance policies adopted by us, were adequate to ensure that Omnitrition's
marketing efforts resulted in a legitimate product marketing and distribution
structure and not an illegal pyramid scheme. We believe that our marketing and
sales programs differ in significant respects from those of Omnitrition, and
that our marketing program complies with applicable law. The two most
significant differences are:
- The Omnitrition marketing plan required associates to purchase $2,000
in merchandise in order to qualify for bonuses as compared to $22 on
autoship under our marketing program; and
- The Omnitrition inventory repurchase policy was limited to products
that were less than three months old as compared to one year under our
inventory repurchase policy.
Lessons from the OMNITRITION case are that:
- A selling program which operates to generate only the minimum purchases
necessary to qualify for bonuses is suspect; and
- A selling program must operate to generate purchases independently of
the payment of bonuses in order to have a legitimate product marketing
and distribution structure.
We believe that our selling program operates to generate significant purchases
"for intrinsic value" as demonstrated by our sales figures. During the month of
December 2003, 18,552 of our associates placed a total of 22,085 orders
averaging $61 in size while only a single $22 on autoship per month is necessary
to qualify for bonuses. In view of the holding of the court of appeals in the
OMNITRITION case, however, there is no assurance that, if challenged, we would
prevail against private plaintiffs alleging violations of anti-pyramid and
securities laws. A final ruling against us in such a suit could result in the
imposition of a material liability against us. Moreover, even if we were
successful in defending against such suit, the costs of such defense, both in
dollars spent and in management time, could be material and adversely affect our
operating results. In addition, the negative publicity of such a suit could
adversely affect our sales and ability to attract and retain associates.
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Nutrition for Life International, Inc., one of our competitors and a
multilevel seller of personal care and nutritional supplements, announced in
January 1997, that it had settled class action litigation brought by associates
alleging fraud in connection with the operation of a pyramid scheme. Nutrition
for Life paid in excess of $3 million to settle claims brought on behalf of its
associates, and related securities fraud claims brought on behalf of certain
purchasers of its stock.
We believe that our marketing program is significantly different from
the program allegedly promoted by Nutrition for Life and that our marketing
program is not in violation of anti-pyramid laws or regulations. Two issues in
the Nutrition for Life matter were a $1,000 buy-in urged on new recruits, and
the paying of commissions on product vouchers prior to the actual delivery of
product. By design, our marketing program offers no incentive to anyone to make
a large personal purchase nor do we use product vouchers. Actual average order
size in December 2003 was $61. However, there is no assurance that claims
similar to the claims brought against Nutrition for Life and other multilevel
marketing organizations will not be brought against us, or that we will prevail
in the event any such claims were made. Furthermore, even if we were successful
in defending against any such claims, the cost of conducting such a defense,
both in dollars spent and in management time, could be material and adversely
affect our operating results and financial condition. In addition, the negative
publicity of such a suit could adversely affect our sales and ability to attract
and retain associates.
INTELLECTUAL PROPERTY
Trademarks. We have developed and use registered trademarks in our
business, particularly relating to the corporate and product names. We use
several trademarks and trade names in connection with our products and
operations. As of December 31, 2003, we had 30 federal trademark registrations
with the United States Patent and Trademark Office. Federal registration of a
trademark enables the registered owner of the mark to bar the unauthorized use
of the registered mark in connection with a similar product in the same channels
of trade by any third party anywhere in the United States, regardless of whether
the registered owner has ever used the trademark in the area where the
unauthorized use occurs. We have filed applications and own trademark
registrations, and we intend to register additional trademarks in foreign
countries where AMS products are or may be sold in the future. Protection
afforded registered trademarks in some jurisdictions may not be as extensive as
the protection available in the United States.
We also claim ownership and protection of certain product names,
unregistered trademarks, and service marks under common law. Common law
trademark rights do not provide the same level of protection afforded by
registration of a trademark. In addition, common law trademark rights are
limited to the geographic area in which the trademark is actually used. We
believe these trademarks, whether registered or claimed under common law,
constitute valuable assets, adding to recognition of AMS and the marketing of
AMS products. We therefore believe that these proprietary rights have been and
will continue to be important in enabling us to compete.
Trade Secrets. We own certain intellectual property, including trade
secrets, which we seek to protect, in part, through confidentiality agreements
with employees and other parties, although some employees involved in research
and development activities have not entered into these agreements. Even where
these agreements exist, there can be no assurance that these agreements will not
be breached, that we would have adequate remedies for any breach, or that our
trade secrets will not otherwise become known to or independently developed by
competitors. Our proprietary product formulations are generally considered trade
secrets, but are not otherwise protected under intellectual property laws.
COMPETITION
The business of developing and distributing nutritional, personal care,
and weight management products such as those we sell and distribute is highly
competitive. Numerous manufacturers, distributors, and retailers compete for
consumers and, in the case of other network marketing companies, for associates.
We compete directly with other entities that develop, manufacture, market, and
distribute products in each of our product lines. We compete with these entities
by emphasizing the underlying science, value, and high quality of our products
as well as the convenience and financial benefits afforded by our network
marketing
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system and compensation plan. However, many of our competitors are substantially
larger and have greater financial resources and broader name recognition. Our
markets are highly sensitive to the introduction of new products that may
rapidly capture a significant share of those markets.
The nutritional supplement market is characterized by:
- Large selections of essentially similar products that are
difficult to differentiate;
- Retail consumer emphasis on value pricing;
- Constantly changing formulations based on evolving scientific
research;
- Low entry barriers resulting from low brand loyalty, rapid
change, widely available manufacturing, low regulatory
requirements, and ready access to large distribution
channels; and
- A lack of uniform standards regarding product ingredient
sources, potency, purity, absorption rate, and form.
Similar factors are also characteristic of products comprising our
other product lines. There can be no assurance that we will be able to
effectively compete in this intensely competitive environment. In addition,
nutritional, personal care, and weight management products can be purchased in a
wide variety of channels of distribution, including retail stores. Our product
offerings in each product category are relatively few compared to the wide
variety of products offered by many of our competitors and are often premium
priced. As a result, our ability to remain competitive depends in part upon the
successful introduction of new products and enhancements of existing products.
We also compete with other network marketing organizations for the
time, attention, and commitment of new and current associates. Our ability to
remain competitive depends, in significant part, on our success in recruiting
and retaining associates. We believe that we offer a rewarding associate
compensation plan and attractive associate benefits and services. To the extent
practicable, our associate compensation plan is designed to be seamless,
permitting international expansion without re-qualification or re-entry
requirements. We pay incentives weekly, reducing the time an associate must wait
between purchase and sale of products and payment of commissions. There can be
no assurance that our programs for recruiting and retaining associates will be
successful. We also compete for the time, attention, and commitment of this
independent associate force. The pool of individuals interested in the business
opportunities presented by network marketing tends to be limited in each market
and is reduced to the extent other network marketing companies successfully
recruit these individuals into their businesses. Although we believe that we
offer an attractive opportunity for our associates, there can be no assurance
that other network marketing companies will not be able to recruit our existing
associates or deplete the pool of potential associates in a given market.
We believe that the leading network marketing company in the world,
based on total sales, is Amway Corporation and its affiliates, and that Avon
Products, Inc. is the leading direct seller of beauty and related products
worldwide. Leading competitors in the nutritional network marketing and
nutritional product industry include Herbalife International, Inc., Market
America, Inc., Nature's Sunshine Products, Inc., NBTY, Nu Skin Enterprises,
Inc., Twinlab Corporation, and Weider Nutrition. We believe there are other
manufacturers of competing product lines that may launch direct selling
enterprises, which will compete with us in certain product lines and for
associates. There can be no assurance that we will be able to successfully meet
the challenges posed by this increased competition.
EMPLOYEES
As of December 31, 2003, we had 58 full-time and 11 part-time
employees, consisting of four executive officers, 23 involved in administrative
activities, eight involved in marketing activities, 22 involved in customer
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service and business development activities and 12 involved in shipping
activities. Our employees are not represented by a labor organization. We
consider our employee relations to be good.
AVAILABILITY OF INFORMATION
We file periodic reports and proxy statements with the Securities and
Exchange Commission, or SEC. The public may read and copy any materials we file
with the SEC at the SEC's Public Reference Room at 450 Fifth Street, N.W.,
Washington, D.C. 20549. The public may obtain information about the operation of
the Public Reference Room by calling the SEC at 1-800-SEC-0330. We file our
reports with the SEC electronically. The SEC maintains an Internet site that
contains reports, proxy and information statements, and other information
regarding issuers that file electronically with the SEC. The address of this
site is http://www.sec.gov.
Our internet address is www.amsonline.com. We make available on our
website, free of charge, copies of our annual report of Form 10-K, quarterly
reports on Form 10-Q, current reports on Form 8-K and amendments to those
reports filed or furnished pursuant to Section 13(a) of the Exchange Act as soon
as reasonably possible after we electronically file such material with, or
furnish to, the SEC.
ITEM 2. PROPERTIES
We maintain our executive offices in our state of the art distribution
and call center located at 711 NE 39th Street, Oklahoma City, OK 73105. The
23,346 square foot, $1.3 million facility was completely paid for in January
2004. We are currently working to sub-lease the previous executive offices at
the Northwest Expressway location, which is still under contract through May 31,
2008, and have lease rental costs of approximately $11,000 per month. All our
properties are in good condition.
ITEM 3. LEGAL PROCEEDINGS
The case of Ronald Potter et al v. Advantage Marketing Systems, Inc. et
al, a products liability claim, was filed in the Oklahoma County District Court
in March 2003. The Plaintiffs allege that the ingestion of ephedra included in
AM-300 resulted in the death of Pamela Sue Potter. We have filed an Answer to
the Petition. Written discovery and responses have been exchanged. Otherwise,
there has been little action in the case. We have denied any wrongdoing and
intend to vigorously defend the claim. The amount of damages sought is unknown,
but includes compensatory and punitive damages.
The case of In re Jose Garcia v. Advantage Marketing Systems, Inc., a
products liability claim, was filed in the Superior Court of California, San
Bernardino County, in February 2003. The Plaintiff claims personal injury and
lost wages resulting from the ingestion of ephedra included in AM-300. We have
filed an Answer to the Petition. Written discovery and responses have been
exchanged. Otherwise, there has been little action in the case. We have denied
any wrongdoing and intend to vigorously defend the claim. The amount of damages
sought is unknown.
On March 5, 2004, we were sued in Ross v. Advantage Marketing Systems,
Inc., Superior Court of the State of California for the County of Los Angeles,
Case No. BC 309118. No answer or other responsive pleading has yet been filed.
The plaintiff alleges that she took AM-300, which contains ephedra, and was
injured as a result. She seeks actual, compensatory and punitive damages, plus
an accounting and disgorgement of profits we purportedly earned as a result of
allegedly illegal conduct. We intend to vigorously defend the case.
On March 8, 2004, we were sued in Purcell v. Advantage Marketing
Systems, Inc. and The Chemins Company, Inc., District Court in and for Pontotoc
County, State of Oklahoma, Case No. C-04-127. No answer or other responsive
pleading has yet been filed. The plaintiff alleges that he took AM-300, which
contains ephedra, and was injured as a result. He seeks actual and punitive
damages in an amount in excess of $10,000. We intend to vigorously defend the
case.
19
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the
fourth quarter of our fiscal year ended December 31, 2003.
PART II
ITEM 5. MARKET FOR REGISTSRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
From November 6, 1997 to June 14, 1999, our common stock was traded on
the Nasdaq SmallCap Market under the symbol "AMSO." On June 15, 1999, our common
stock began trading on the American Stock Exchange under the symbol "AMM."
On March 19, 2004, the closing sale price of our common stock on the
American Stock Exchange was $5.25. We believe there are approximately 1,606
holders of our common stock. The following table sets forth the high and low
closing sale price of our common stock on the American Stock Exchange.
COMMON STOCK
CLOSING BID PRICES
------------------
HIGH LOW
---- ---
2003--CALENDAR QUARTER ENDED:
March 31......................................... $1.79 $1.20
June 30.......................................... $1.49 $1.15
September 30..................................... $2.99 $1.21
December 31...................................... $6.59 $2.80
2002--CALENDAR QUARTER ENDED:
March 31......................................... $2.60 $1.95
June 30.......................................... $3.05 $1.96
September 30..................................... $2.35 $1.90
December 31...................................... $2.00 $1.20
We have never declared or paid cash dividends on our common stock. We
currently intend to retain future earnings, if any, to fund the development and
growth of our business. Future cash dividends, if any, will be determined by the
Board of Directors and will be based on earnings, available capital, financial
condition, and other factors deemed relevant by the Board of Directors.
Equity Compensation Plan Information
(c)
Number of securities
remaining available
for future issuance
(a) (b) under equity
Number of securities to Weighted-average compensation plans
be issued upon exercise exercise price of (excluding securities
of outstanding options, outstanding options, reflected in
Plan Category warrants and rights warrants and rights column (a))
- ------------- ------------------- ------------------- ---------------------
Equity plans approved by
security holders............ 2,261,808 $2.06 863,192
Equity compensation plan
not approved by security
holders(1).................. 430,000 $1.92 --
--------- -------
Total....................... 2,691,808 $2.04 863,192
========= =======
(1) Prior to approval of the 1995 Stock Option Plan, the Company issued
673,250 incentive stock options to employees and associates, 430,000 of which
remain outstanding. These options have a term of 10 years, are exercisable, in
whole or in part, at any time prior to the termination date, and have an
exercise price of $1.75 to $2.00 per share. The options may be assigned or
transferred, in whole or in part, so long as such assignment or transfer is in
accordance with and subject to the provisions of the Securities Act of 1933, as
amended, and the rules promulgated thereunder.
20
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial and statistical data,
computed as a percentage of net sales, for the years ended December 31, 2003,
2002, 2001, 2000 and 1999. The selected financial data are derived from our
audited consolidated financial statements and should be read in conjunction with
them and the notes thereto. The results of operations for the periods presented
are not necessarily indicative of our future operations.
YEAR ENDED DECEMBER 31,
-----------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
INCOME STATEMENT DATA:
Net sales............................ $18,486,178 $22,303,581 $28,440,920 $26,707,936 $22,427,551
Cost of sales........................ 12,750,336 15,126,983 19,231,150 17,929,701 15,610,941
----------- ----------- ----------- ----------- -----------
Gross profit..................... 5,735,842 7,176,598 9,209,770 8,778,235 6,816,610
Marketing, distribution and
administrative expenses:
Marketing ....................... 1,538,981 2,487,006 2,304,922 2,981,372 1,691,978
Distribution and administrative.. 7,242,167 5,768,245 6,875,871 5,076,436 3,544,960
----------- ----------- ----------- ----------- -----------
Total marketing, distribution and
administrative expenses ......... 8,781,148 8,255,251 9,180,793 8,057,808 5,236,938
Goodwill impairment.................. -- 3,788,374 -- -- --
----------- ----------- ----------- ----------- -----------
Income (loss) from operations ... (3,045,306) (4,867,027) 28,977 720,427 1,579,672
Other income (expense):
Interest and dividends,net....... (74,704) (53,895) (31,800) 310,599 364,270
Other income (expense)........... (39,690) (39,170) 16,841 (81,560) 7,866
----------- ----------- ----------- ----------- -----------
Total other income (expense) ........ (114,394) (93,065) (14,959) 229,039 372,136
----------- ----------- ----------- ----------- -----------
Income (loss) before income taxes (3,159,700) (4,960,092) 14,018 949,466 1,951,808
Income tax (benefit)................. (590,839) (1,755,057) 5,467 456,532 676,025
----------- ----------- ----------- ----------- -----------
Net income (loss).................... $(2,568,861) $(3,205,035) $ 8,551 $ 492,934 $ 1,275,783
=========== =========== =========== =========== ===========
Net income (loss) per common
share-basic...................... $ (0.57) $ (0.73) $ -- $ 0.12 $ 0.31
=========== =========== =========== =========== ===========
Net income (loss) per common
share-assuming dilution.......... $ (0.57) $ (0.73) $ -- $ 0.09 $ 0.27
=========== =========== =========== =========== ===========
Weighted average common shares
outstanding-basic ............... 4,508,986 4,419,196 4,379,486 4,283,461 4,139,706
=========== =========== =========== =========== ===========
Weighted average common shares
outstanding-assuming dilution.... 4,508,986 4,419,196 4,692,298 5,476,277 4,778,576
=========== =========== =========== =========== ===========
STATISTICAL DATA:
Total cost of sales.............. 69.0% 67.8% 67.6% 67.1% 69.6%
Gross profit..................... 31.0% 32.2% 32.4% 32.9% 30.4%
Total marketing, distribution
and administrative expense....... 47.5% 37.0% 32.3% 30.2% 23.4%
Net income (loss)................ (13.9)% (14.4)% 0.0% 1.8% 5.7%
CASH FLOW DATA:
Net cash provided by (used in)
operating activities ............ $(1,042,590) $ 694,712 $ 1,508,177 $ (62,480) $2,370,939
Net cash provided by (used in)
investing activities............. (237,197) 68,193 (1,383,960) (885,350) (5,473,205)
Net cash provided by (used in)
financing activities............. 2,381,769 (537,795) 781,284 (638,377) (524,057)
BALANCE SHEET DATA:
Total assets .................... $12,204,019 $10,686,269 $14,672,404 $11,690,250 $12,160,383
Total liabilities ............... 3,910,156 3,355,840 4,127,226 1,266,345 1,928,400
Stockholders' equity............. 8,293,863 7,330,429 10,545,178 10,423,905 10,231,983
21
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
The following discussion should be read in conjunction with our consolidated
financial statements and notes thereto under Item 8 below.
GENERAL
Since 1996, our business and operations have been significantly
affected by the acquisitions of, or acquisitions of the assets of, Miracle
Mountain International, Inc., Chambre International, Inc., Stay 'N Shape
International, Inc., Solution Products International, Inc., Nation of Winners,
Inc., Now International, Inc. , ToppMed Inc. and LifeScience Technologies Inc.,
or LST. Over the years, these acquisitions and asset purchases have added 11,790
associates to our ranks and 129 products to our product line.
LST was our most recent acquisition. On January 4, 2001, we purchased
the LST group of companies for $1.2 million and a five year payment of $41,667
per month, or 5% of the gross sales of LST products, whichever is greater. The
seller had the option to take up to 860,000 shares of our common stock in lieu
of cash at an option price of $3.00 per share. As a result of this acquisition,
we added 14 products and over 5,000 associates. We paid the balance of the
acquisition price, plus accrued interest, in full on January 29, 2004.
We have historically earned a material portion of our revenues from our
AM-300 product, which contains ephedra. In 2003, the FDA banned the use of
ephedra in nutritional supplements. While the FDA's decision had an adverse
effect on our 2003 revenues, we had been preparing for this contingency. Over
the last several years, through strategic acquisitions, product redevelopment
and refocus of weight loss products, we have built a multi-product peak
performance, weight loss and nutritional product line that is predominately
non-ephedra. We have seen positive results in converting our AM-300 customers to
AM-300 Ephedra Free or other weight loss products in states like New York,
Illinois and California that have previously banned ephedra. A majority of the
customers have chosen one or more of our other performance-based weight loss and
nutritional products. We anticipate the same positive results with our remaining
AM-300 customers. As a result, we do not anticipate that the FDA ban on ephedra
will materially impact our financial condition or results of operations.
The following table sets forth information used by management to assess
our results of operations over the prior three (3) years, both in aggregate
amounts and the percentage increase or decrease over the prior year:
%increase %increase
2003 (decrease) 2002 (decrease) 2001
---- ---------- ---- ---------- ----
Net sales ........................... $18,486,178 (17.1)% $22,303,581 (21.6)% $28,440,920
Gross profit ........................ 5,735,842 (20.1) 7,176,598 (22.1) 9,209,770
Net Income (Loss) ................... (2,568,861) 19.8 (3,205,035) (37,481.4) 8,551
Free Cash Flow(1) ................... (1,449,481) (6,256.5) (22,802) 92.2 (290,722)
Average Monthly Purchases per
Associate(2) ........................ $ 61 5.2 $ 58 107.1 $ 28
Total Associates .................... 44,000 0.1 40,000 (44.4) 72,000
Active Associates ................... 19,000 (51.3) 39,000 (44.3) 70,000
(1) Free cash flow is defined as cash flow from operations minus capital
expenditures.
2003 2002 2001
------------ --------- -----------
Cash flow from operations.... ($ 1,042,590) $ 694,713 $1,508,177
Capital expenditures......... 406,891 717,515 1,798,899
------------ --------- -----------
Free cash flow............... ($ 1,449,481) ($ 22,802) ($ 290,722)
============ ========= ===========
(2) Average monthly purchases per associates is calculated by dividing total
sales by total number of associate transactions.
22
Below we discuss the reasons for the reductions in the above matrices for 2003
versus 2002 and 2001. To reverse this trend, we have emphasized the recruiting
of new sales associates as our best model for growth in 2004. We believe we can
attract and retain experienced and new sales associates through our WellnessCEO
system, our new compensation plan, our refocused product offerings, and our new
customer acquisition program.
Critical Accounting Policies. We prepare our consolidated financial
statements in conformity with accounting principles generally accepted in the
United States, which require us to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosures of contingent
assets and liabilities at the date of the financial statements and the reported
amounts of revenue and expenses during the year. Actual results could differ
from those estimates. We consider the following policies to be most critical in
understanding the judgments that are involved in preparing our financial
statements and the uncertainties that could impact our results of operations,
financial condition and cash flows.
Throughout this report, "net sales" represents the gross sales amounts
reflected on our invoices to our associates less associate discounts, sales
returns, and, beginning June 1, 2001, a portion of freight costs. All of our
products include a customer satisfaction guarantee. Our products may be returned
within 30 days of purchase for a full refund or credit toward the purchase of
another product. We also have a buy-back program whereby we repurchase products
sold to an independent associate (subject to a restocking fee), provided the
associate terminates his/her associateship agreement with us and returns the
product within 12 months of original purchase in marketable condition. We
receive our net sales price in cash or through credit card payments upon receipt
of orders from associates.
Our "gross profit" consists of net sales less:
- Commissions and bonuses, consisting of commission payments to
associates based on their current associate level within their
organization, and other one-time incentive cash bonuses to
qualifying associates;
- Cost of products, consisting of the prices we pay to our
manufacturers for products and royalty overrides earned by
qualifying associates on sales within their associate
organizations; and
- A portion of the cost of shipping, consisting of costs related to
shipments, duties and tariffs, freight expenses relating to
shipment of products to associates, and similar expenses.
We recognize revenue upon shipment of products, training aids and promotional
material to our independent associates. All of our customers pay for sales in
advance of shipment. As such, we have no trade receivables. We used to make
loans to associates, which were repayable in five years or less, and which were
secured by commissions controlled by us. Associate loans are no longer allowed.
Interest rates on loans were typically two percent or more above the Prime rate
and were fixed. All loans and receivables were secured by guaranteed payment
sources that were within our control. As such, there was no need for an
allowance for doubtful accounts. We were still collecting on prior associate
loans as of December 31, 2003 in the total amount of $241,878.
23
In July 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 142, "Goodwill and Other Intangible
Assets". This standard requires companies to stop amortizing existing goodwill
and intangible assets with indefinite lives effective January 1, 2002. Under the
new rules, companies would only adjust the carrying amount of goodwill or
indefinite life intangible assets upon an impairment of the goodwill or
indefinite life intangible assets. We implemented these standards effective
January 1, 2002. Based on an evaluation of goodwill at October 31, 2002, we
determined that goodwill of approximately $3,800,000 was 100% impaired and
should be written off in its entirety.
We write down our inventory to provide for estimated obsolete or
unsalable inventory based on assumptions about future demand for our products
and market conditions. If future demand and market conditions are less favorable
than management's assumptions, additional inventory write-downs could be
required. Likewise, favorable future demand and market conditions could
positively impact future operating results if written-off inventory is sold.
We account for contingencies in accordance with SFAS No. 5, "Accounting
for Contingencies". SFAS 5 requires that we record an estimated loss from a loss
contingency when information available prior to issuance of our financial
statements indicates that it is probable than an asset has been impaired or a
liability has been incurred at the date of the financial statements and the
amount of the loss can be reasonable estimated. Accounting for contingencies
such as legal and income tax matters requires us to use our judgment. Many legal
and tax contingencies can take years to resolve. Generally, as the time period
increases over which the uncertainties are resolved, the likelihood of changes
to the estimate of the ultimate outcome increases. However, an adverse outcome
in these matters could have a material impact on our results of operations,
financial condition and cash flows.
Units Offering. On November 12, 1997, we completed the offering of
1,495,000 units, each consisting of one share of common stock and one redeemable
common stock purchase warrant. Each redeemable common stock purchase warrant was
exercisable for the purchase of one share of our common stock for $3.40 on or
before November 6, 2002. In connection with this offering, we sold to the
underwriters, Paulson Investment Company, Inc. and Joseph Charles & Assoc.,
Inc., warrants exercisable for the purchase of 130,000 units for $5.40 per unit
on or before November 6, 2002. On September 16, 2002, we extended the exercise
period for the redeemable stock purchase warrants and the underwriter warrants
from November 6, 2002 to November 12, 2003. On October 14, 2003, we extended the
exercise period for the redeemable stock purchase warrants and the underwriter
warrants from November 12, 2003 to November 12, 2004. On December 10, 2003 we
announced the redemption of all outstanding redeemable stock purchase warrants
and the underwriter warrants not exercised by January 16, 2004. Rather than have
their warrants redeemed, substantially all of the holders of the redeemable
stock purchase warrants and the underwriter warrants exercised their warrants on
or before the redemption date. Proceeds from the exercise of the redeemable
stock purchase warrants and the underwriter warrants totaled $5,394,615. The
redemption price for the unexercised warrants totaled $11,870.
Warrant Modification Offering and Rights Offering. In January 1997, we
distributed non-transferable rights to our common stock shareholders. These
rights entitled the holders to subscribe for and purchase up to 2,148,191 units,
each unit consisting of one share of our common stock and one 1997-A warrant,
for the price of $6.80 per unit. Concurrently, we called and redeemed our
outstanding class A and class B common stock purchase warrants for $.0008 per
warrant on March 17, 1997. However, in connection with the warrant redemption,
we offered to the holders of the class A and class B warrants the right to
purchase units, each comprised of one share of common stock and one 1997-A
warrant, at an exercise price of $6.00 per unit.
Each 1997-A warrant was exercisable on or before November 6, 2002, to
purchase one share of common stock for $3.40, subject to adjustment in certain
events. On September 16, 2002, we extended the exercise period for the 1997-A
warrants from November 6, 2002 to November 12, 2003. On October 14, 2003, we
extended the exercise period for the 1997-A warrants from November 12, 2003 to
November 12, 2004. On December 10, 2003, we announced the redemption of all
outstanding 1997-A warrants not exercised by January 16, 2004. Rather than have
their warrants redeemed, substantially all of the holders of the 1997-A warrants
24
exercised their warrants on or before the redemption date. Proceeds from the
exercised of the 1997-A warrants totaled $714,877. The redemption price for the
unexercised warrants totaled $25.
In January 2004, we issued 1,170,064 shares of common stock upon
exercise of the redeemable stock purchase warrants, the underwriter warrants and
the 1997-A warrants.
RESULTS OF OPERATIONS
Comparison of 2003 and 2002
Our net sales during the year ended December 31, 2003, decreased by
$3,817,403, or 17.1%, to $18,486,178 from $22,303,581 during the year ended
December 31, 2002. During 2003, we made sales to approximately 44,000
associates, compared to sales during 2002 to approximately 40,000 associates.
The aggregate number of associates at December 31, 2003 was down from 2002 due
to decreased recruiting activity. At December 31, 2003, we had approximately
19,000 "active" associates compared to approximately 39,000 at December 31,
2002. An associate is considered to be "active" if he or she has made a product
purchase of $50 or more from us or is enrolled in our autoship program within
the previous 90 days. Sales per associate per month increased to $61 for 2003,
compared to $58 for 2002.
Our cost of sales during 2003 decreased by $2,376,647, or 15.7%, to
$12,750,336 from $15,126,983 during 2002. This decrease was attributable to
reduced sales, resulting in:
- A decrease of $1,469,426 in associate commissions and bonuses;
- A decrease of $764,519 in the cost of products sold; and
- A decrease of $142,702 in shipping costs.
Total cost of sales as a percentage of net sales increased to 69.0% during the
year ended December 31, 2003, from 67.8% during the same period in 2002. This
was primarily due to an increase in cost of shipping to 8.3% of net sales from
7.5%, which was due to increased rates, and an increase in commissions and
bonuses to 42.1% of net sales from 41.5%. This increase was partially offset by
a decrease in cost of products sold to 18.5% of net sales from 18.8% due to
efficiency in inventory purchasing and carrying cost.
Our gross profit decreased $1,440,756 or 20.1%, to $5,735,842 during
2003 from $7,176,598 during 2002. The gross profit decreased as a percentage of
net sales to 31.0% in 2003 from 32.2% in 2002, as reflected in our cost of goods
sold increase as a percentage of net sales.
Marketing, distribution and administrative expenses increased $525,897
or 6.4%, to $8,781,148 during the year ended December 31, 2003, from $8,255,251
during the same period in 2002. This increase was primarily attributable to:
- An increase in executive employee costs of approximately $670,000
related to the accrual of future payments on employment agreements;
- An increase in bonus expense of approximately $320,000 related to
exercise of employee stock options;
- An increase in information systems consulting expense of approximately
$95,000 due to changes in Internet programs;
- An increase in consulting expense of approximately $70,000 related to
executive management consulting;
- An increase of approximately $68,000 in legal expenses related to the
current litigation;
- An increase in vehicle expense of approximately $65,000 related to the
write down of vehicles;
- An increase in bad debt expense of $24,500 due to the write off of
uncollectible associate advances; and
- A loss on sale of assets of approximately $117,000.
25
The increase in marketing, distribution and administrative expenses were
partially offset by:
- A decrease in convention expenses of approximately $330,000 related to
lower costs for our annual convention and regional conferences;
- A decrease in promotion costs of approximately $200,000;
- A decrease in administrative expense of approximately $155,000, related
primarily to decreases in bank charges and executive dues;
- A decrease in travel expense of approximately $144,000; and
- A decrease of approximately $99,000 in rent and insurance costs related
to better rates for liability insurance and to the lease expiration on
our old warehouse building.
The marketing, distribution and administrative expenses as a percentage
of net sales increased to 47.5% in 2003, from 37.0% in 2002.
In July 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No. 142, "Goodwill and Other Intangible
Assets". This standard required companies to stop amortizing existing goodwill
and other intangible assets with indefinite lives effective January 1, 2002.
Under the new rules, companies would only adjust the carrying amount of goodwill
or indefinite life intangible assets upon an impairment of the goodwill or
indefinite life intangible assets. We implemented this standard effective
January 1, 2002. Upon an evaluation at October 31, 2002, we determined that
goodwill was impaired and should be written off in its entirety. This resulted
in a one-time impairment charge of $3,788,374, or 17.0% of net sales for 2002.
Our net other expense increased by $21,329 to net other expense of
$114,394 during 2003, from a net other expense of $93,065 during the same period
in 2002. This increase was primarily due to:
- A decrease in investment income of $15,000 related to marketable
securities; and
- A loss on sale of marketable securities of $14,000.
Our loss before taxes decreased $1,800,392 to a loss of $3,159,700
during 2003, from a loss of $4,960,092 during 2002. Income (loss) before taxes
as a percentage of net sales was (17.1%) and (22.2%) during 2003 and 2002.
Income tax expense (benefit) during 2003 and 2002 was ($590,839) and
($1,755,057). Our net loss decreased $636,174, to a net loss of $2,568,861
during 2003, from a net loss of $3,205,035 during 2002. This decrease in net
loss was attributable to:
- The decrease in gross profit to $5,735,842 during 2003 from $7,176,598
during 2002;
- The impairment of goodwill of $3,788,374 in 2002;
- The increase in marketing, distribution and administrative expense to
$8,781,148 during 2003 from $8,255,251 during 2002; and
- The creation of a deferred tax valuation allowance of $441,000.
Net loss as a percentage of net sales decreased to (13.9%) during 2003, from
(14.4%) during 2002.
26
Comparison of 2002 and 2001
Our net sales during the year ended December 31, 2002, decreased by
$6,137,339, or 21.6%, to $22,303,581 from $28,440,920 during the year ended
December 31, 2001. During 2002, we made sales to approximately 40,000
associates, compared to sales during 2001 to approximately 71,597 associates.
The aggregate number of associates at December 31, 2002 decreased 2001 due to
decreased recruiting activity. At December 31, 2002, we had approximately 39,000
"active" associates compared to approximately 69,700 at December 31, 2001 due to
decreased recruiting. Sales per associate per month increased to $58 for 2002,
compared to $28 for 2001.
Our cost of sales during 2002 decreased by $4,104,167, or 21.3%, to
$15,126,983 from $19,231,150 during 2001. This decrease was attributable to
reduced sales, resulting in:
- A decrease of $2,432,420 in associate commissions and bonuses;
- A decrease of $1,279,169 in the cost of products sold; and
- A decrease of $391,582 in shipping costs.
Total cost of sales as a percentage of net sales increased to 67.8% during the
year ended December 31, 2002, from 67.6% during the same period in 2001. This
was primarily due to an increase in cost of shipping to 7.5% of net sales from
7.3%, which was due to increased rates, and an increase in commissions and
bonuses to 41.5% of net sales from 41.1%. This increase was partially offset by
a decrease in cost of products sold to 18.8% of net sales from 19.2% due to
efficiency in inventory purchasing and carrying cost.
Our gross profit decreased $2,033,172, or 22.1%, to $7,176,598 during
2002 from $9,209,770 during 2001. The gross profit decreased as a percentage of
net sales to 32.2% in 2002 from 32.4% in 2001, as reflected in our cost of goods
sold increase as a percentage of net sales.
Marketing, distribution and administrative expenses decreased $925,542,
or 10.1%, to $8,255,251 during the year ended December 31, 2002, from $9,180,793
during the same period in 2001. This decrease was primarily attributable to:
- Non-recurring expenses in 2001 of approximately $255,000 related to the
operation of the LifeScience Technologies California warehouse in
January and February of 2001, plus the transition costs related to the
LifeScience Technologies acquisition in January 2001;
- A decrease in depreciation and amortization expense of approximately
$167,000, due to the cessation of goodwill amortization in 2002 per
FASB 142 (See Note 1 to our financial statements);
- A decrease in professional services expense of approximately $300,000
due to the buyout of options in 2001, and a change in auditing firm in
2002, saving us approximately $76,000; and
- A decrease in contract services from 2001 of $193,600 incurred to
supplement our technical staff during the LifeScience Technologies
acquisition transition.
The marketing, distribution and administrative expenses as a percentage
of net sales increased to 37.0% in 2002, from 32.3% in 2001.
In July 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No. 142, "Goodwill and Other Intangible
Assets". This standard required companies to stop amortizing existing goodwill
and other intangible assets with indefinite lives effective January 1, 2002.
Under the new rules, companies would only adjust the carrying amount of goodwill
or indefinite life intangible assets upon an impairment of the goodwill or
indefinite life intangible assets. We implemented this standard effective
January 1, 2002. Upon an evaluation at October 31, 2002, we determined that
goodwill was impaired and should be written off in its entirety. This resulted
in a one-time impairment charge of $3,788,374, or 17.0% of net sales for 2002.
27
Our net other expense increased by $78,106 to net other expense of
$93,065 during 2002, from a net other expense of $14,959 during the same period
in 2001. This increase was primarily due to:
- A decrease in investment income of $28,000 related to marketable
securities offset by an increase in interest income of $22,000;
- A decrease in collection of written off accounts receivable of $11,000
related to collection of old, outstanding debt;
- A loss on sale of marketable securities of $30,000; and
- A loss on sale of assets of $17,500.
Our income (loss) before taxes decreased $4,974,110, to a loss of
$4,960,092 during 2002, from income of $14,018 during 2001. Income (loss) before
taxes as a percentage of net sales was (22.2%) and 0.0% during 2002 and 2001.
Income tax expense (benefit) during 2002 and 2001 was $(1,755,057) and $5,467.
Our net income (loss) decreased $3,213,586, to a net loss of $3,205,035 during
2002, from a net income of $8,551 during 2001. This decrease in net income
(loss) was attributable to:
- The increase in net other expense to $93,065 during 2002 from net other
expense of $14,959 during 2001;
- The decrease in gross profit to $7,176,598 during 2002 from $9,209,770
during 2001;
- The impairment of goodwill of $3,788,374; and
- The decrease in marketing, distribution and administrative expense to
$8,255,251 during 2002 from $9,180,793 during 2001.
Net income as a percentage of net sales decreased to (14.4%) during 2002, from
0.0% during 2001.
Seasonality
No pattern of seasonal fluctuations exists. However, there is no
assurance that we will not become subject to seasonal fluctuations in the
future.
ACCOUNTING STANDARDS TO BE ADOPTED
In January 2003, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 46 (FIN 46), "Consolidation of Variable Interest Entities"
(VIEs), which is an interpretation of Accounting Research Bulletin (ARB) No. 51,
"Consolidated Financial Statements." FIN 46, as revised by FIN 46 (R), addresses
the application of ARB No. 51 to VIEs, and generally would require that assets,
liabilities and results of the activity of a VIE be consolidated into the
financial statements of the enterprise that is considered the primary
beneficiary. This interpretation applies immediately to VIEs created after
January 31, 2003, and to VIEs in which a company obtains an interest after that
date. We have not created or obtained an interest in any VIEs. In addition, the
interpretation becomes applicable on December 31, 2003 for special purpose
entities (SPEs) created prior to February 1, 2003. As of December 31, 2003, we
had no SPEs for which we were considered the primary beneficiary. For non-SPEs
in which a company holds a variable interest that it acquired before February 1,
2003, the FASB has postponed the date on which the interpretation will become
applicable to March 31, 2004. We have determined the adoption of the provisions
of FIN 46, as revised by FIN 46(R), will not have a material effect on our
financial condition or results of operations.
In November 2003, the Emerging Issues Task Force (EITF) of the FASB
reached a consensus on one issue with respect to EITF Issue 03-1, "The Meaning
of Other-Than-Temporary Impairment and its Application to Certain Investments,"
thereby requiring certain quantitative and qualitative disclosures for
securities accounted for under SFAS No. 115, "Accounting for Certain Investments
in Debt and Equity
28
Securities," that are impaired at the balance sheet date but for which an
other-than-temporary impairment has not been recognized. Adoption of EITF Issue
03-1, which was effective for us on December 31, 2003, did not have a material
impact on our financial position, results of operations or cash flows. The
required disclosures have been considered in Note 3 to our consolidated
financial statements.
In December 2003, the Staff of the Securities and Exchange Commission
(SEC) issued Staff Accounting Bulletin (SAB) No. 104, "Revenue Recognition,"
which supersedes SAB No. 101. The primary purpose of SAB No. 104 is to rescind
accounting guidance contained in SAB No. 101 and the SEC's "Revenue Recognition
in Financial Statements Frequently Asked Questions and Answers" (the FAQ)
related to multiple element revenue arrangements in order to make this
interpretive guidance consistent with current authoritative accounting and
auditing guidance and SEC rules and regulations. We do not expect the issuance
of SAB No. 104 to significantly impact our current revenue recognition policies.
In May 2003, the FASB issued Statement of Financial Accounting
Standards No. 150, "Accounting for Certain Financial Instruments with
Characteristics of Both Liabilities and Equity" (SFAS 150). SFAS No. 150 changes
the accounting for certain financial instruments that, under previous guidance,
could be classified as equity or "mezzanine" equity, by now requiring those
instruments to be classified as liabilities (or assets in some circumstances) in
the consolidated balance sheets. Further, SFAS No. 150 requires disclosure
regarding the terms of those instruments and settlement alternatives. The
guidance in SFAS No. 150 generally is effective for all financial instruments
entered into or modified after May 31, 2003, and was otherwise effective at the
beginning of the first interim period beginning after June 15, 2003. We have
evaluated SFAS No. 150 and determined that it does not have an impact on our
financial reporting and disclosures.
COMMITMENTS AND CONTINGENCIES
Recent Regulatory Developments - As a marketer of products that are
ingested by consumers, we are subject to the risk that one or more of the
ingredients in our products may become the subject of adverse regulatory action.
For a discussion regarding the impact of regulatory developments on our
business, please see "Business - Regulation".
Product Liability - We, like other marketers of products that are
intended to be ingested, face the inherent risk of exposure to product liability
claims in the event that the use of our products results in injury. We maintain
limited product liability insurance coverage with limits of $1,000,000 per
occurrence and $2,000,000 in the aggregate. Products containing ephedra, which
represented approximately 35.9% of our 2003 net sales, are not covered by our
product liability insurance. We generally do not obtain contractual
indemnification from our product manufacturers. However, all of our product
manufacturers carry product liability insurance, which covers our products. A
product liability claim could result in material losses.
Legal Proceedings - We are currently involved in five products
liability suits related to the ingestion of our ephedra-based products. Answers
to these petitions have been or soon will be filed, and written discovery and
responses have been or soon will be exchanged. We have, and will continue to,
deny any wrongdoing and intend to vigorously defend against the claims. The
amounts of damages sought are unknown, but include compensatory and punitive
damages.
LIQUIDITY AND CAPITAL RESOURCES
Our primary source of liquidity has been cash provided by sales of our
common stock, marketable securities and operating activities. At December 31,
2003, we had working capital of $4,420,554 compared to $3,186,583 at December
31, 2002. We also added $1,170,064 in January 2004 from the exercise of
warrants. During the year ended December 31, 2003, net cash used in operating
activities was $1,042,590 net cash used in investing activities was $237,197,
and net cash provided by financing activities was $2,381,769. We had a net
increase in cash during this period of $1,101,982. Our working capital needs
over the next 12 months consist primarily of marketing, distribution and
administrative expenses, and will be provided by our operating activities and
existing cash and cash equivalents. Capital expenditures and debt retirement
will be paid from our net proceeds generated from our warrant redemption.
29
In 2001, we completed construction of a 23,346 square foot distribution
and call center facility in Oklahoma City. This project was funded, in part,
with bank loans of $980,000 for the land and building and $166,216 for the
warehouse equipment. Both loans were with Bank One Oklahoma, N.A. and accrue
interest at an annual rate of .25% under the prime rate. The loans were retired
in January 2004. As of January 31, 2004, we had no long-term debt outstanding.
The following summarizes our contractual obligations at December 31,
2003 and the effect such obligations are expected to have on our liquidity and
cash flow in future periods.
LESS THAN 1 3 - 5
TOTAL YEAR 1 - 3 YEARS YEARS
----- ---- ----------- -----
Bank loans and notes (1)......... $1,989,170 $ 485,161 $1,500,611 $ 3,398
Capital lease obligations........ 244,248 91,831 100,703 51,714
Operating leases................. 649,850 132,278 265,886 251,686
---------- ----------- ---------- --------
Total............................ $2,883,268 $ 709,270 $1,867,200 $306,798
========== =========== ========== ========
(1) See Note 4 to our financial statements. All of our bank loans and notes were
paid in their entirety in January 2004.
At December 31, 2003, we had marketable debt and equity securities of
$1,876,978 compared to $1,621,143 at December 31, 2002. All of our securities
are unrestricted investments.
During the first quarter of 1998, we agreed to loan John W. Hail, our
Chief Executive Officer and a major shareholder, up to $250,000. Subsequently we
also agreed to loan up to an additional $75,000. In 2000, an additional $200,000
was approved. On January 1, 2001 the outstanding balance on all the notes plus
interest were combined into one note payable in monthly installments. Our board
of directors unanimously approved the loans and extension. These loans are
collateralized by stock and property, and bear interest at 8% per annum. These
loans were paid in full in 2003. No new loans will be made to our officers or
directors.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our balance sheet includes marketable securities, which we believe are
a conservative blend of income and growth investments resulting in moderate
market risk. We invest in equity marketable securities to generate capital
growth, and fixed-income marketable securities to provide current income.
Because of the nature of these investments, both current interest rates and
equity market movements will affect total return and risk. Our fixed income
investments of approximately $800,000 are subject to interest risk and market
value risk. We have approximately $1,000,000 of equity investments that are
exposed to market risk.
Interest Rate Risk. We currently maintain an investment portfolio of
high-quality fixed-income marketable securities. All securities are available
for sale and recorded in the balance sheet at fair value with fluctuations in
fair value reported as a component of accumulated other comprehensive income in
stockholders equity. We do not hedge our investment portfolio or our outstanding
credit facility or other long-term indebtedness. Fixed-income investments with a
maturity date of three months or less at the date of purchase are deemed to be
cash equivalents. Any remaining fixed-income securities are considered
short-term and mainly consist of investments in U.S. Treasury notes and bonds.
The following table lists our cash equivalents and our short-term
fixed-income marketable securities at December 31, 2003 and December 31, 2002:
DECEMBER 31, 2003 DECEMBER 31, 2002
----------------- -----------------
AVERAGE AVERAGE
INTEREST FAIR INTEREST FAIR
RATE (1) COST VALUE RATE (1) COST VALUE
-------- ---- ----- -------- ---- -----
Cash equivalents... --% $ 17,709 $ 17,709 --% $ 18,208 $ 18,208
Short-term
Investments...... --% 787,551 786,855 6.00% 787,180 801,339
-------- -------- -------- --------
$805,260 $804,564 $805,388 $819,547
======== ======== ======== ========
(1) Average interest rate is calculated by taking the individual security
interest rates multiplied by each investment's weighted average share of the
total fixed-income marketable securities.
30
At December 31, 2003 all of our fixed income securities were in mutual
funds, creating no average interest rates for fixed income securities.
Fair value of the cash equivalents and fixed-income marketable
securities decreased $14,983 during the year ended December 31, 2003 to $804,564
from $819,547 at December 31, 2002. This decrease was primarily due to net
redemption of fixed income securities.
Equity Market Risks. We currently maintain an investment portfolio of
equity securities. All securities are available for sale and recorded in the
balance sheet at fair value with fluctuations in fair value reported as a
component of accumulated other comprehensive income in stockholders equity. We
do not engage in hedging our equity portfolio or otherwise purchase derivative
securities. Because of the quality of our portfolio and liquid nature of our
equity investments, we do not consider the market risk related to these
investments to be material. At December 31, 2003, our equity investments had a
value of $1,072,414 compared to $801,596 at December 31, 2002, primarily due to
the purchase of mutual fund equity investments in the second, third and fourth
quarters of 2003.
We attempt to manage our interest and market risk by evaluating and
purchasing what we believe to be the best investment securities and rates of
return available.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our consolidated financial statements are set forth beginning on page
F-1 hereof.
ITEM 9. CHANGES IN AND DISAGREEMENT WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
As of the end of the period covered by this report, an evaluation
was carried out under the supervision and with the participation of our
management, including our Chief Executive Officer and Chief Financial Officer,
of the effectiveness of the design and operation of our disclosure controls and
procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of
1934) as required by Rule 13a-15(b). Based upon that evaluation, the Chief
Executive Officer and Chief Financial Officer concluded that the design and
operation of these disclosure controls and procedures were effective. Our Chief
Executive Officer and Chief Financial Officer have also concluded that there
have not been any changes in our internal control over financial reporting that
has materially affected, or is reasonably likely to materially affect, our
internal control over financial reporting.
PART III
In accordance with the provisions of General Instruction G (3),
information required by Items 10, 11, 12, 13 and 14 of Form 10-K are
incorporated herein by reference to our Proxy Statement for the Annual Meeting
of Shareholders to be filed prior to April 29, 2004.
31
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM
8-K
(a)(1) The following financial statements of Advantage Marketing
Systems, Inc. are included in Item 8:
Report of Independent Certified Public Accountants............................................ F-2
Consolidated Balance Sheets as of December 31, 2003 and 2002.................................. F-3
Consolidated Statements of Operations for Years Ended December 31, 2003, 2002 and 2001........ F-4
Consolidated Statements of Stockholders' Equity for Years Ended December 31, 2003, 2002 and
2001........................................................................................ F-5
Consolidated Statements of Cash Flows for Years Ended December 31, 2003, 2002 and 2001........ F-6
Notes to Consolidated Financial Statements for Years Ended December 31, 2003 2002 and 2001.... F-7
(a)(2) Financial Statement Schedules
All other schedules have been omitted since the required information is
not present, or not present in amounts sufficient to require submission of the
schedule, or because the information required is included in the consolidated
financial statements or notes thereto.
(a)(3) Exhibits
EXHIBIT NO. DESCRIPTION
- ----------- -----------
3.1 The Registrant's Certificate of Incorporation, incorporated by
reference to the Registration Statement on Form SB-2
(Registration No. 333-47801) filed with the commission on
March 11, 1998.
3.2 The Registrant's Bylaws, incorporated by reference to the
Registration Statement on Form SB-2 (Registration No.
333-47801) filed with the commission on March 11, 1998.
10.1 Warrant Agreement between Registrant and U.S. Stock Transfer
Inc., dated as of January 16, 1997, as amended and restated
January 8, 1998, incorporated by reference to Amendment No. 2
to Form 8-A Registration Statement, filed with the Commission
on January 13, 1998.
10.2 Unit and Warrant Agreement between Registrant and U.S. Stock
Transfer Inc., dated as of November 6, 1997, as amended and
restated January 8, 1998, incorporated by reference to
Amendment No. 1 to Form 8-A Registration Statement, filed with
the Commission on January 15, 1998.
10.5 Purchase and Assignment Agreement by and among Advantage
Marketing Systems, Inc., LifeScience Technologies Holdings,
Inc., GHI Holdings, Inc., LifeScience Technologies, Inc. and
RMS Limited Partnership, dated as of January 3, 2001,
incorporated by reference to Form 8-K filed with the
Commission on January 8, 2001.
10.6 Promissory Note dated January 3, 2001, to RMS Limited
Partnership by Advantage Marketing Systems, Inc., LifeScience
Technologies Holdings, Inc., LifeScience Technologies Holdings
Limited Partnership, LifeScience Technologies Holdings, Inc.,
LifeScience Technologies of Japan and LST Fulfillment Limited
Partnership, incorporated by reference to Form 8-K filed with
the Commission on January 8, 2001.
10.7 Stock Option Agreement of Advantage Marketing Systems dated
January 3, 2001, incorporated by reference to Form 8-K filed
with the Commission on January 8, 2001.
10.8 Joint Marketing Agreement with PrimeBuy Network.com, Inc.,
dated August 30, 2002, incorporated by reference to Form 10-Q
filed with the Commission on November 1, 2002.
32
10.9 Promissory Note executed by PrimeBuy Network.com, Inc., dated
August 2, 2002, incorporated by reference to Form 10-Q filed
with the Commission on November 1, 2002.
10.10* The Advantage Marketing Systems, Inc. 1995 Stock Option
Plan, incorporated by reference to Form SB-2 Registration
Statement (No. 33-80629), filed with the Commission on
November 20, 1996.
10.11* Employment Agreement by and between David D'Arcangelo and
Registrant dated effective as of November 25, 2002,
incorporated by reference to Form 10-K/A filed with the
Commission on March 31, 2003.
10.12* Non-Qualified Stock Option Agreement by and between David
D'Arcangelo and Registrant dated effective as of December 2,
2002, incorporated by reference to Form 10-K/A filed with the
Commission on March 31, 2003.
10.13* The Advantage Marketing Systems, Inc. 2003 Stock Incentive
Plan, incorporated by reference to Form S-8 Registration
Statement (No. 333-109093), filed with the Commission on
September 24, 2003.
10.14 Fulfillment Services Agreement with Vita Sales & Distribution
Multi-Country, dated January 19, 2004, filed herewith.
10.15* Employment Agreement by and between John W. Hail and
Registrant dated effective as of November 4, 2003, filed
herewith.
21 Subsidiaries, incorporated by reference to Form 10-K filed
with the Commission on April 17, 2001.
23.1 Consent of Grant Thornton LLP, filed herewith.
31.1 Chief Executive Officer Certification, filed herewith.
31.2 Chief Financial Officer Certification, filed herewith.
32.1 Section 1350 Certification of our Chief Executive Officer,
filed herewith.
32.2 Section 1350 Certification of our Chief Financial Officer,
filed herewith.
* Designates a compensatory plan.
(b) Reports on Form 8-K.
- On December 10, 2003, the registrant filed an 8-K
reporting its intent to redeem all of its outstanding
1997-A Warrants, its Redeemable Common Stock Purchase
Warrants and its Underwriter Warrants.
- On November 4, 2003, the registrant filed an 8-K
reporting its financial results for the three months
and nine months ended September 30, 2003.
- On October 16, 2003, the registrant filed an 8-K
reporting the extension of the exercise period of its
1997-A Warrants, its Redeemable Common Stock Purchase
Warrants and its Underwriter Warrants from November
12, 2003 to November 12, 2004.
33
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
REGISTRANT:
ADVANTAGE MARKETING SYSTEMS, INC.
Date: March 29, 2004 By: /S/ JOHN W. HAIL
----------------------------------
John W. Hail, Chief Executive Officer,
Chairman of the Board and Director
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Date: March 29, 2004 By: /S/ JOHN W. HAIL
----------------------------------
John W. Hail, Chief Executive Officer,
Chairman of the Board and Director
Date: March 29, 2004 By: /S/ REGGIE B. COOK
----------------------------------
Reggie B. Cook, Chief Financial
Officer and Secretary Treasurer
Date: March 29, 2004 By: /S/ DAVID J. D'ARCANGELO
----------------------------------
David J. D'Arcangelo, President
and Director
Date: March 29, 2004 By: /S/ DENNIS P. LONEY
----------------------------------
Dennis P. Loney, Chief Operational
Officer
Date: March 29, 2004 By: /S/ M. THOMAS BUXTON III
----------------------------------
M. Thomas Buxton III, Director
Date: March 29, 2004 By: /S/ STEVEN M. DICKEY
----------------------------------
Steven M. Dickey, Director
Date: March 29, 2004 By: /S/ HARLAND C. STONECIPHER
----------------------------------
Harland C. Stonecipher, Director
Date: March 29, 2004 By: /S/ STEVEN R. HAGUE
----------------------------------
Steven R. Hague, Director
34
INDEX TO FINANCIAL STATEMENTS
PAGE
----
ADVANTAGE MARKETING SYSTEMS, INC. AND SUBSIDIARIES
AUDITED CONSOLIDATED FINANCIAL STATEMENTS:
Report of Independent Certified Public Accountants............................................. F-2
Consolidated Balance Sheets as of December 31, 2003 and 2002................................... F-3
Consolidated Statements of Operations for Years Ended December 31, 2003, 2002 and 2001......... F-4
Consolidated Statements of Stockholders' Equity for Years Ended December 31, 2003, 2002 and
2001........................................................................................... F-5
Consolidated Statements of Cash Flows for Years Ended December 31, 2003,
2002 and 2001.................................................................................. F-6
Notes to Consolidated Financial Statements for
Years Ended December 31, 2003 2002 and 2001..................................................... F-7
F-1
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors and Stockholders
Advantage Marketing Systems, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheets of Advantage
Marketing Systems, Inc. and Subsidiaries as of December 31, 2003 and 2002, and
the related consolidated statements of operations, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 2003. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Advantage Marketing
Systems, Inc. and Subsidiaries as of December 31, 2003 and 2002, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 2003, in conformity with accounting principles
generally accepted in the United States of America.
As discussed in Note 1 to the consolidated financial statements, the Company
adopted Statement of Financial Accounting Standards No. 142, Goodwill and Other
Intangibles, on January 1, 2002.
GRANT THORNTON LLP
Oklahoma City, Oklahoma
February 17, 2004
F-2
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2003 AND 2002
2003 2002
---- ----
ASSETS
CURRENT ASSETS:
Cash and cash equivalents ............................................... $ 2,309,281 $ 1,207,299
Marketable securities, available for sale, at fair value ................ 1,876,978 1,621,143
Receivables ............................................................. 416,919 123,838
Receivable from affiliates .............................................. -- 63,561
Prepaid taxes and income tax receivable ................................. 464,975 464,975
Inventory ............................................................... 901,529 798,153
Deferred income taxes ................................................... 4,854 120,343
Other assets ............................................................ 41,212 31,215
------------ ------------
Total current assets ................................................... 6,015,748 4,430,527
RECEIVABLES ............................................................... 232,809 338,839
PROPERTY AND EQUIPMENT, net ............................................... 3,461,733 3,905,432
COVENANTS NOT TO COMPETE and other intangibles, net ....................... 558,004 635,821
DEFERRED INCOME TAXES .................................................... 1,883,172 1,276,859
OTHER ASSETS .............................................................. 52,553 98,791
------------ ------------
TOTAL ..................................................................... $ 12,204,019 $ 10,686,269
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable ........................................................ $ 357,696 $ 219,533
Accrued commissions and bonuses ......................................... 215,062 171,310
Accrued other expenses .................................................. 328,136 151,289
Accrued sales tax liability ............................................. 130,185 136,618
Notes payable ........................................................... 485,161 455,296
Capital lease obligations ............................................... 78,954 109,898
------------ ------------
Total current liabilities .............................................. 1,595,194 1,243,944
LONG-TERM LIABILITIES:
Notes payable ........................................................... 1,504,009 1,989,332
Capital lease obligations ............................................... 142,880 122,564
Deferred compensation ................................................... 668,073 --
------------ ------------
Total liabilities ...................................................... 3,910,156 3,355,840
------------ ------------
COMMITMENTS AND CONTINGENCIES (Notes 5 and 12)
STOCKHOLDERS' EQUITY:
Common stock - $.0001 par value; authorized 495,000,000 shares; issued
5,905,307 and 4,896,674 shares; outstanding 5,432,512 and
4,424,314 shares, respectively ......................................... 590 490
Paid-in capital ......................................................... 15,160,183 11,793,240
Notes receivable for exercise of options ................................ (31,000) (31,000)
Accumulated deficit ..................................................... (4,687,718) (2,118,857)
Accumulated other comprehensive income (loss), net of tax ............... 96,284 (68,968)
------------ ------------
Total capital and accumulated deficit ................................... 10,538,339 9,574,905
Less cost of treasury stock (472,795 shares) ............................ (2,244,476) (2,244,476)
------------ ------------
Total stockholders' equity ............................................. 8,293,863 7,330,429
------------ ------------
TOTAL ..................................................................... $ 12,204,019 $ 10,686,269
============ ============
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
F-3
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
2003 2002 2001
------------ ------------ ------------
Net sales .................................................. $ 18,486,178 $ 22,303,581 $ 28,440,920
Cost of sales .............................................. 12,750,336 15,126,983 19,231,150
------------ ------------ ------------
Gross profit .............................................. 5,735,842 7,176,598 9,209,770
Marketing, distribution and administrative expenses:
Marketing ............................................... 1,538,981 2,487,006 2,304,922
Distribution and administration ......................... 7,242,167 5,768,245 6,875,871
------------ ------------ ------------
Total marketing, distribution and administrative expenses .. 8,781,148 8,255,251 9,180,793
Goodwill impairment ........................................ -- 3,788,374 --
------------ ------------ ------------
Income (loss) from operations ............................. (3,045,306) (4,867,027) 28,977
Other income (expense):
Interest and dividends, net ................................ (74,704) (53,895) (31,800)
Other income (expense), net ................................ (39,690) (39,170) 16,841
------------ ------------ ------------
Total other income (expense) .............................. (114,394) (93,065) (14,959)
------------ ------------ ------------
INCOME (LOSS) BEFORE TAXES ................................. (3,159,700) (4,960,092) 14,018
INCOME TAX EXPENSE (BENEFIT) ............................... (590,839) (1,755,057) 5,467
------------ ------------ ------------
NET INCOME (LOSS) .......................................... $ (2,568,861) $ (3,205,035) $ 8,551
============ ============ ============
Net income (loss) per common share - basic ................. $ (.57) $ (.73) $ --
============ ============ ============
Net income (loss) per common share - assuming dilution ..... $ (.57) $ (.73) $ --
============ ============ ============
Weighted average common shares outstanding - basic ......... 4,508,986 4,419,196 4,379,486
============ ============ ============
Weighted average common shares - assuming dilution ......... 4,508,986 4,419,196 4,692,298
============ ============ ============
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
F-4
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
NOTES RETAINED
RECEIVABLE EARNINGS
SHARES FOR (ACCUMU-
(SEE COMMON PAID-IN EXERCISE LATED
NOTE 6) STOCK CAPITAL OF OPTIONS DEFICIT)
----------- ----------- ----------- ----------- -----------
BALANCE,
JANUARY 1, 2001 ........... 4,348,814 $ 482 $11,642,188 $ (31,088) $ 1,077,627
Options exercised with
cash ...................... 61,000 6 121,994 -- --
Comprehensive Income:
Net Income ................. -- -- -- -- 8,551
Unrealized loss on
available for sale
securities, net of tax..... -- -- -- -- --
Comprehensive income ....... -- -- -- -- --
----------- ----------- ----------- ----------- -----------
BALANCE,
DECEMBER 31, 2001 ......... 4,409,814 488 11,764,182 (31,088) 1,086,178
Options exercised with
cash ...................... 14,500 2 29,058 -- --
Payments of notes
receivable ................ -- -- -- 88 --
Comprehensive Income:
Net Loss ................... -- -- -- -- (3,205,035)
Unrealized loss on
available for sale
securities, net of tax..... -- -- -- -- --
Comprehensive Loss ......... -- -- -- -- --
----------- ----------- ----------- ----------- -----------
BALANCE,
DECEMBER 31, 2002 ......... 4,424,314 490 11,793,240 (31,000) (2,118,857)
Options exercised with
cash ...................... 369,838 37 1,090,483 -- --
Warrants exercised with
cash ...................... 581,575 58 2,131,217 -- --
Stock issued ............... 56,785 5 145,243 -- --
Comprehensive Income:
Net Loss ................... -- -- -- -- (2,568,861)
Unrealized gain on
available for sale
securities, net of tax..... -- -- -- -- --
Comprehensive (Loss) ....... -- -- -- -- --
----------- ----------- ----------- ----------- -----------
BALANCE,
DECEMBER 31, 2003 ......... 5,432,512 $ 590 $15,160,183 $ (31,000) $(4,687,718)
=========== =========== =========== =========== ===========
ACCUMU-
LATED
OTHERCOM-
PREHENSIVE
COMPRE- INCOME TOTAL
HENSIVE (LOSS), STOCK-
INCOME NET TREASURY HOLDERS'
(LOSS) OF TAX STOCK EQUITY
----------- ----------- ----------- -----------
BALANCE,
JANUARY 1, 2001 ........... $ (20,828) $(2,244,476) $10,423,905
Options exercised with
cash ...................... -- -- -- 122,000
Comprehensive Income:
Net Income ................. 8,551 -- -- 8,551
Unrealized loss on
available for sale
securities, net of tax..... (9,278) (9,278) -- (9,278)
-----------
Comprehensive income ....... $ (727) -- -- --
=========== ------------ ----------- -----------
BALANCE,
DECEMBER 31, 2001 ......... (30,106) (2,244,476) 10,545,178
Options exercised with
cash ...................... -- -- -- 29,060
Payments of notes
receivable ................ -- -- -- 88
Comprehensive Income:
Net Loss ................... (3,205,035) -- -- (3,205,035)
Unrealized loss on
available for sale
securities, net of tax..... (38,862) (38,862) -- (38,862)
-----------
Comprehensive Loss ......... $(3,243,897) -- -- --
=========== ------------ ----------- -----------
BALANCE,
DECEMBER 31, 2002 ......... (68,968) (2,244,476) 7,330,429
Options exercised with
cash ...................... -- -- -- 1,090,520
Warrants exercised with
cash ...................... -- -- -- 2,131,275
Stock issued ............... -- -- -- 145,248
Comprehensive Income:
Net Loss ................... (2,568,861) -- -- (2,568,861)
Unrealized gain on
available for sale
securities, net of tax..... 165,252 165,252 -- 165,252
-----------
Comprehensive (Loss) ....... $(2,403,609) -- -- --
=========== ------------ ----------- -----------
BALANCE,
DECEMBER 31, 2003 ......... $ 96,284 $(2,244,476) $ 8,293,863
============ =========== ===========
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
F-5
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
2003 2002 2001
---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)............................................. $(2,568,861) $(3,205,035) $ 8,551
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Depreciation and amortization ............................... 982,168 1,016,260 1,112,870
Goodwill impairment ......................................... -- 3,788,374 --
Stock issued for services ................................... 73,600 -- --
Employee compensation recognized upon exercise of stock
options .................................................... 282,653 -- --
Deferred taxes .............................................. (590,839) (1,331,778) 43,189
(Gain) loss on sale of assets ............................... 117,273 17,568 (7,904)
Realized (gain) loss on sale of marketable securities ....... 52,557 33,841 (3,714)
Impairment of inventory and other assets .................... -- 116,143 --
Changes in assets and liabilities which provided (used) cash:
Receivables ................................................ (310,645) 200,988 57,561
Inventory .................................................. (103,377) 421,156 466,112
Prepaid taxes and income tax receivable .................... -- (365,855) 183,241
Other assets ............................................... 2,478 183,854 (764)
Accounts payable and accrued expenses ...................... 352,330 (180,803) (350,965)
Deferred compensation ...................................... 668,073 -- --
----------- ----------- -----------
Net cash provided by (used in) operating activities ....... (1,042,590) 694,713 1,508,177
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment .......................... (406,891) (717,515) (1,798,899)
Sales of property and equipment .............................. 25,678 284,438 26,442
Advances to affiliates ....................................... -- 36,438 --
Advances to notes receivable ................................. -- -- (24,864)
Receipts on notes receivable ................................. 123,593 85,631 105,167
Repayment of related party receivables ....................... 63,562 433,036 61,360
Purchase of marketable securities, available for sale ........ (1,240,980) (1,817,520) (15,259)
Sale of marketable securities, available for sale ............ 1,197,841 1,763,685 1,840,067
Purchase of other intangibles ................................ -- -- (428,338)
Acquisition of new business, net of cash acquired ............ -- -- (1,149,636)
----------- ----------- -----------
Net cash provided by (used in) in investing activities .... (237,197) 68,193 (1,383,960)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock ....................... 879,515 29,061 122,000
Proceeds from exercise of warrants ........................... 2,131,275 -- --
Proceeds from notes payable .................................. -- -- 1,146,216
Repayments of notes receivable for exercise of stock options.. -- 88 --
Payment of notes payable ..................................... (486,586) (455,295) (348,454)
Principal payment on capital lease obligations ............... (142,435) (111,649) (138,478)
----------- ----------- -----------
Net cash provided by (used in) financing activities ....... 2,381,769 (537,795) 781,284
----------- ----------- -----------
NET INCREASE IN CASH AND CASH EQUIVALENTS ..................... 1,101,982 225,111 905,501
CASH AND CASH EQUIVALENTS, BEGINNING .......................... 1,207,299 982,188 76,687
----------- ----------- -----------
CASH AND CASH EQUIVALENTS, ENDING ............................. $ 2,309,281 $ 1,207,299 $ 982,188
=========== =========== ===========
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
F-6
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION - The consolidated financial statements
include the accounts of Advantage Marketing Systems, Inc. and its
wholly owned subsidiaries, Miracle Mountain International, Inc. and
Chambre' International, Inc. (the "Company"). All significant
intercompany accounts have been eliminated.
NATURE OF BUSINESS - The Company markets a product line of consumer
oriented products in the weight management, dietary supplement and
personal care categories that are produced by various manufacturers.
The Company sells its product line through a network of full and
part-time independent associates. The Company also sells supplies and
materials to its independent associates.
USE OF ESTIMATES - The preparation of financial statements in
conformity with accounting principles generally accepted in the United
States of America requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
REVENUE RECOGNITION - The Company recognizes revenue upon shipment of
products, training aids and promotional material to the independent
associates.
LOANS AND TRADE RECEIVABLES - All of the Company's customers pay for
sales in advance of shipment. As such, the Company has no trade
receivables. Loans to associates are repayable in five years or less;
are secured by commissions controlled by the Company; and are no longer
allowed. Interest rates on loans are typically two percent or more
above the Prime rate and are fixed.
CREDIT LOSSES AND DOUBTFUL ACCOUNTS - All loans and receivables are
collateralized by guaranteed payment sources that are within the
Company's control. As such, management believes there is no need for an
allowance for doubtful accounts.
SALES RETURNS - All of the Company's products include a customer
satisfaction guarantee. Company products may be returned within 30 days
of purchase for a full refund or credit toward the purchase of another
Company product. The Company also has a buy-back program whereby it
will repurchase products sold to an independent associate (subject to a
restocking fee) provided that the associate terminates his/her
associateship agreement with the Company and returns the product within
12 months of original purchase in marketable condition. The cost of
products returned to the Company is included in net sales. For the
years ended December 31, 2003, 2002 and 2001, the cost of products
returned to the Company was less than one percent of gross sales.
CASH AND CASH EQUIVALENTS - Cash and cash equivalents consist of cash
in banks and all short term investments with initial maturities of
three months or less. The Company maintains its cash and cash
equivalents in accounts that may not be federally insured. The Company
has not experienced any losses in such accounts and believes it is not
exposed to any significant credit risk.
MARKETABLE SECURITIES - All of the Company's marketable securities are
classified as available for sale and reported at fair value. The
related unrealized gains and losses are excluded from earnings and
reported net of income tax as a separate component of stockholders'
equity until realized. Realized gains and losses on sales of securities
are based on the specific identification method. Declines in the fair
F-7
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 (CONT.)
value of investment securities below their carrying value that are
other than temporary are recognized in earnings.
INVENTORY - Inventory consists of consumer product inventory and
training and promotional material such as video tapes, cassette tapes
and paper supplies held for sale to customers and independent
associates. Inventory is stated at the lower of cost or market. Cost is
determined on a first-in, first-out method.
SHIPPING AND HANDLING COSTS - Shipping and handling costs are included
as a component of cost of goods sold. Fees charged to customers for
shipping and handling are included in sales.
INTANGIBLES - Intangible assets consist of covenants not to compete and
other intangibles, which have a significant residual value. Covenants
not to compete are being amortized over the life of the contracts.
The table below details the gross carrying amount and accumulated
amortization:
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------
2003 2002 2001
---- ---- ----
Non-compete covenants, gross ...... $ 644,000 $ 644,000 $ 644,000
Other intangibles, gross .......... 428,338 428,338 428,338
---------- ---------- ----------
Total intangibles, gross $1,072,338 $1,072,338 $1,072,338
========== ========== ==========
Accumulated amortization, non-
compete covenants ............... $ 450,083 $ 393,683 $ 337,283
Accumulated amortization, other
intangibles ..................... 64,251 42,834 21,417
---------- ---------- ----------
Total accumulated amortization $ 514,334 $ 436,517 $ 358,700
========== ========== ==========
Intangible amortization for the years ended December 31, 2003, 2002 and
2001, was $77,817 per year. Estimated amortization expense for the
years 2004, 2005 and 2006 is $77,817 and estimated amortization expense
for the years 2007 and 2008 is $46,134.
PROPERTY AND EQUIPMENT - Property and equipment are stated at cost or,
in the case of leased assets under capital leases, at the fair value of
the leased property and equipment, less accumulated depreciation and
amortization. Property and equipment are depreciated using the
straight-line method over the estimated useful lives of the assets of
three to 20 years. Assets under capital leases and leasehold
improvements are amortized over the lesser of the term of the lease or
the life of the asset.
LONG-LIVED ASSETS - Management of the Company assesses recoverability
of its long-lived assets whenever events or changes in circumstances
indicate that the carrying value of the asset may not be recoverable
through future cash flows generated by that asset. Recoverability is
assessed and measured on long-lived assets using an estimate of the
undiscounted future cash flows attributable to the asset. Impairment is
measured based on future cash flows discounted at an appropriate rate.
FAIR VALUE DISCLOSURE - The Company's financial instruments include
cash and cash equivalents, marketable securities, receivables,
short-term payables, notes payable and capital lease obligations. The
carrying amounts of cash and cash equivalents, receivables and
short-term payables approximate fair value due to their short-term
nature. Marketable securities held for sale are carried at fair value.
The carrying amounts of capital lease obligations approximate fair
value based on borrowing rates currently
F-8
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 (CONT.)
available to the Company. Notes payable with carrying amounts of
$1,989,170 and $2,444,628 had fair values of approximately $2,050,000
and $2,520,000 at December 31, 2003 and 2002, respectively.
EARNINGS (LOSS) PER SHARE - Earnings (loss) per common share is
computed based upon net income (loss) divided by the weighted average
number of common shares outstanding during each period. Earnings (loss)
per common share-assuming dilution is computed based upon net income
(loss) divided by the weighted average number of common shares
outstanding during each period adjusted for the effect of dilutive
potential common shares calculated using the treasury stock method. The
following is a reconciliation of the common shares used in the
calculations of earnings (loss) per common share and earnings (loss)
per common share - assuming dilution:
INCOME (LOSS) SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ------
For the year ended December 31, 2003:
Loss per common share:
Loss available to common stockholders ................... $(2,568,861) $ (0.57)
========
Weighted average common shares outstanding .............. 4,508,986
Loss per common share - assuming dilution:
Options ................................................. -- --
----------- -----------
Loss available to common stockholders
plus assumed conversions ............................... $(2,568,861) 4,508,986 $ (0.57)
=========== =========== ========
For the year ended December 31, 2002:
Loss per common share:
Loss available to common stockholders ................... $(3,205,035) $ (0.73)
========
Weighted average common shares outstanding .............. 4,419,196
Loss per common share - assuming dilution:
Options ................................................. -- --
----------- -----------
Loss available to common stockholders plus
assumed conversions ...................................... $(3,205,035) 4,419,196 $ (0.73)
=========== =========== ========
For the year ended December 31, 2001:
Earnings per common share:
Income available to common stockholders ................. $ 8,551 $ --
========
Weighted average common shares outstanding .............. 4,379,486
Earnings per common share - assuming dilution:
Options ................................................. -- 312,812
----------- -----------
Income available to common stockholders plus
assumed conversions .................................... $ 8,551 4,692,298 $ --
=========== =========== ========
Options to purchase 2,691,808 shares of common stock at exercise prices
ranging from $1.30 to $6.13 per share were outstanding at December 31,
2003 but were not included in the computation of loss per common
share-assuming dilution because all options were antidilutive. At
December 31, 2003, 359,996 common shares issuable pursuant to the terms
of a convertible acquisition note payable were excluded from the
determination of diluted loss per share under the if-converted method,
because the effect of inclusion was antidilutive.
Options to purchase 1,756,653 shares of common stock at exercise prices
ranging from $1.31 to $6.13 per share were outstanding at December 31,
2002 but were not included in the computation of loss per common
share-assuming dilution because such inclusion would not be dilutive.
At December 31, 2002, 526,664 common shares issuable pursuant to the
terms of a convertible acquisition note payable were
F-9
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 (CONT.)
excluded from the determination of diluted loss per share under the
if-converted method, because the effect of inclusion was antidilutive.
Options to purchase 1,193,691 shares of common stock at exercise prices
ranging from $2.95 to $6.13 per share were outstanding at December 31,
2001 but were not included in the computation of earnings per common
share-assuming dilution because the options' exercise price was greater
than the average market price of the common shares. At December 31,
2001, 693,332 common shares issuable pursuant to the terms of a
convertible acquisition note payable were excluded from the
determination of diluted earnings per share under the if converted
method because the effect of inclusion was antidilutive.
Warrants to purchase 1,353,073 shares of common stock at exercise
prices ranging from $3.40 to $5.40 per share at December 31, 2003 and
warrants to purchase 1,874,768 shares of common stock at exercise
prices ranging from $3.40 to $5.40 per share at December 31, 2002 and
2001 were outstanding but were not included in the computation of
earnings per common share-assuming dilution because the warrants'
exercise price was greater than the average market price of the common
shares.
ACCOUNTING STANDARDS YET TO BE ADOPTED - In January 2003, the Financial
Accounting Standards Board (FASB) issued Interpretation No. 46 ("FIN
46"), "Consolidation of Variable Interest Entities" (VIEs), which is an
interpretation of Accounting Research Bulletin (ARB) No. 51,
"Consolidated Financial Statements." FIN 46, as revised by FIN 46 (R),
addresses the application of ARB No. 51 to VIEs, and generally would
require that assets, liabilities and results of the activity of a VIE
be consolidated into the financial statements of the enterprise that is
considered the primary beneficiary. This interpretation applies
immediately to VIEs created after January 31, 2003, and to VIEs in
which a company obtains an interest after that date. The Company has
not created or obtained an interest in any VIEs. In addition, the
interpretation becomes applicable on December 31, 2003 for special
purpose entities (SPEs) created prior to February 1, 2003. As of
December 31, 2003, the Company had no SPEs for which it was considered
the primary beneficiary. For non-SPEs in which a company holds a
variable interest that it acquired before February 1, 2003, the FASB
has postponed the date on which the interpretation will become
applicable to March 31, 2004. The Company has determined the adoption
of the provisions of FIN 46, as revised by FIN 46(R), will not have a
material effect on its financial condition or results of operations.
In November 2003, the Emerging Issues Task Force or EITF of the FASB
reached a consensus on one issue with respect to EITF Issue 03-1, "The
Meaning of Other-Than-Temporary Impairment and its Application to
Certain Investments," thereby requiring certain quantitative and
qualitative disclosures for securities accounted for under SFAS No.
115, "Accounting for Certain Investments in Debt and Equity
Securities," that are impaired at the balance sheet date but for which
an other-than-temporary impairment has not been recognized. Adoption of
EITF Issue 03-1, which was effective for us on December 31, 2003, did
not have a material impact on the Company's financial position, results
of operations or cash flows. The required disclosures have been
considered in Note 3 to the consolidated financial statements.
In December 2003, the Staff of the Securities and Exchange Commission
(SEC) issued Staff Accounting Bulletin (SAB) No. 104, "Revenue
Recognition," which supersedes SAB No. 101. The primary purpose of SAB
No. 104 is to rescind accounting guidance contained in SAB No. 101 and
the SEC's "Revenue Recognition in Financial Statements Frequently Asked
Questions and Answers" (the FAQ) related to multiple element revenue
arrangements in order to make this interpretive guidance consistent
with current authoritative accounting and auditing guidance and SEC
rules and regulations. The Company does not expect the issuance of SAB
No. 104 to significantly impact its current revenue recognition
policies.
F-10
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 (CONT.)
In May 2003, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 150, "Accounting for
Certain Financial Instruments with Characteristics of Both Liabilities
and Equity" (SFAS 150"). SFAS No. 150 changes the accounting for
certain financial instruments that, under previous guidance, could be
classified as equity or "mezzanine" equity, by now requiring those
instruments to be classified as liabilities (or assets in some
circumstances) in the consolidated balance sheets. Further, SFAS No.
150 requires disclosure regarding the terms of those instruments and
settlement alternatives. The guidance in SFAS No. 150 generally is
effective for all financial instruments entered into or modified after
May 31, 2003, and was otherwise effective at the beginning of the first
interim period beginning after June 15, 2003. The Company has evaluated
SFAS No. 150 and determined that it does not have an impact on its
financial reporting and disclosures.
COMPREHENSIVE INCOME - The Company classifies other comprehensive
income items by their nature in the financial statements and displays
the accumulated balance of other comprehensive income separately in the
stockholders' equity section of the balance sheet. The Company's only
other comprehensive income item is related to unrealized gains (losses)
on investment securities classified as available for sale.
2003 2002 2001
---- ---- ----
Unrealized gain (loss) on investment arising during
the period................................................. $ 120,915 $ (69,299) $(5,564)
Less reclassification adjustment for gains (losses)
included in net earnings.................................. (44,337) (30,437) 3,714
--------- --------- -------
Unrealized gain (loss) on investment, net of income
taxes of $100,000, $23,517 and $5,615, respectively $ 165,252 $ (38,862) $(9,278)
========= ========= =======
INCOME TAXES - The Company uses an asset and liability approach to
account for income taxes. Deferred income taxes are recognized for the
tax consequences of temporary differences and carryforwards by applying
enacted tax rates applicable to future years to differences between the
financial statement amounts and the tax bases of existing assets and
liabilities. A valuation allowance is established if, in management's
opinion, it is more likely than not that some portion of the deferred
tax asset will not be realized.
GOODWILL - During 2001, goodwill was amortized using the straight-line
method over 7 to 20 years and the Company assessed the recoverability
of goodwill by determining whether the amortization of the asset
balance over its remaining life could be recovered through the
undiscounted future operating cash flows of the acquired operation. The
amount of impairment, if any, was measured based on projected
discounted future operating cash flows. Effective January 1, 2002, the
Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets"
and ceased amortizing goodwill. Major provisions of this statement are
as follows:
- Intangible assets acquired in a business combination must be
recorded separately from goodwill if they arise from
contractual or other legal rights or are separable from the
acquired entity and can be sold, transferred, licensed,
rented, or exchanged, either individually or as a part of a
related contract, asset, or liability;
- Goodwill and intangible assets with indefinite lives are not
amortized but are tested for impairment at least annually,
except in certain circumstances, and whenever there is an
impairment indicator; and
F-11
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 (CONT.)
- All acquired goodwill must be assigned to reporting units for
purposes of impairment testing and segment reporting.
The following table reconciles reported net income (loss) and related
per share amounts to amounts that would have been presented exclusive
of amortization expense recognized for goodwill that is no longer being
amortized (tax-effected):
YEARS ENDED DECEMBER 31,
------------------------
2003 2002 2001
---- ---- ----
Reported net income (loss) ....... $ (2,568,861) $ (3,205,035) $ 8,551
Add back: Goodwill amortization . -- -- 141,733
------------- ------------- -----------
Adjusted net income (loss) ....... $ (2,568,861) $ (3,205,035) $ 150,284
============= ============= ===========
BASIC EARNINGS (LOSS) PER SHARE:
Reported net income (loss) ..... $ (.57) $ (.73) $ .00
Goodwill amortization .......... -- -- .03
------------- ------------- -----------
Adjusted net income (loss) ..... $ (.57) $ (.73) $ .03
============= ============= ===========
DILUTED EARNINGS (LOSS) PER SHARE:
Reported net income (loss) ..... $ (.57) $ (.73) $ .00
Goodwill amortization .......... -- -- .03
------------- ------------- -----------
Adjusted net income (loss) ..... $ (.57) $ (.73) $ .03
============= ============= ===========
The Company evaluated its goodwill as of the adoption of SFAS No. 142
on January 1, 2002 and determined that there were no indicators of
impairment since the Company's market capitalization was in excess of
the value of identifiable net assets as of January 1, 2002. The Company
obtained a valuation from an independent third-party appraiser.
The Company updated its analysis of goodwill impairment as of October
31, 2002 and determined that there was an indicator of impairment of
its recorded goodwill; accordingly, the Company completed the second
phase of impairment testing. Based on the impairment test, the Company
recognized an impairment of approximately $3.8 million as of December
31, 2002, which eliminated goodwill in its entirety.
F-12
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 (CONT.)
The impairment was required because economic conditions at the time of
testing reduced the market capitalization of the Company to a level
below the value of identifiable net assets. Under SFAS No. 142, an
impairment adjustment recognized after adoption is required to be
recognized as an operating expense.
ADVERTISING COSTS - The Company expenses the cost of advertising the
first time advertising takes place. Advertising expense for the years
ended December 31, 2003, 2002 and 2001 was approximately $696, $2,254
and $38,704, respectively.
STOCK-BASED COMPENSATION - The Company applies Accounting Principles
Board Opinion No. 25 and related interpretations in accounting for its
stock-based compensation awards. Accordingly, no compensation cost has
been recognized for stock options granted in the accompanying
consolidated financial statements. The following pro forma data is
calculated net of tax as if compensation cost for the Company's
stock-based compensation awards (see also Note 6) was determined based
upon the fair value at the grant date consistent with the methodology
prescribed under SFAS No. 123.
Years Ended December 31,
------------------------
2003 2002 2001
---- ---- ----
Net income (loss) as reported ........................................ $(2,568,861) $(3,205,035) $ 8,551
Adjustment, net of tax .............................................. (622,275) (141,610) (426,941)
----------- ----------- -----------
Proforma net loss ................................................... $(3,191,136) $(3,346,645) $ (418,390)
Net income (loss) per common share as reported........................ $ (.57) $ (.73) $ --
Adjustment, net of tax .............................................. (.14) (.03) (.10)
----------- ----------- -----------
Proforma net loss per common share, basic and diluted ................ $ (.71) $ (.76) $ (.10)
Weighted average common shares outstanding, basic and diluted ........ 4,508,986 4,419,196 4,379,486
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option pricing model with the following
weighted average assumptions used for grants in 2003, 2002 and 2001,
respectively: risk-free interest rates of 2.89, 2.92 and 4.86 percent;
no dividend yield or assumed forfeitures; expected lives of 5.0 years;
and volatility of 75, 55 and 63 percent. The pro forma amounts above
are not likely to be representative of future years because there is no
assurance that additional awards will be made each year.
F-13
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 (CONT.)
2. MARKETABLE SECURITIES
Investments in securities are summarized as follows:
DECEMBER 31, 2003
-----------------
COST/ GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
Type of investment COST GAINS LOSSES VALUE
---- ----- ------ -----
Short term investments - available for sale..... $ 17,709 $ -- $ -- $ 17,709
========== ========= ======== ==========
Debt securities - available for sale
Mutual Funds ................................... $ 787,551 $ 6,875 $ (7,571) $ 786,855
---------- --------- -------- ----------
$ 787,551 $ 6,875 $ (7,571) $ 786,855
========== ========= ======== ==========
Equities - available for sale
Mutual Funds ................................... $ 921,605 $ 150,809 $ -- $1,072,414
---------- --------- -------- ----------
$ 921,605 $ 150,809 $ -- $1,072,414
========== ========= ======== ==========
$1,726,865 $ 157,684 $ (7,571) $1,876,978
========== ========= ======== ==========
F-14
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 (CONT.)
Cost/ Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Type of investment Cost Gains Losses Value
------------------ ---- ----- ------ -----
Short term investments - available for sale.. $ 18,208 $ -- $ -- $ 18,208
=========== =========== =========== ===========
Debt securities - available for sale
U.S. Treasury and other U.S. government
corporations and agencies ................ $ 100,250 $ 344 $ -- $ 100,594
Foreign bonds, notes and debentures ........ 24,930 -- (148) 24,782
Mutual Funds ............................... 662,000 14,057 (94) 675,963
----------- ----------- ----------- -----------
$ 787,180 $ 14,401 $ (242) $ 801,339
=========== =========== =========== ===========
Equities - available for sale
Preferred Stock ............................ $ 38,089 $ 4,457 $ (312) $ 42,234
Mutual Funds ............................... 892,804 -- (133,442) 759,362
----------- ----------- ----------- -----------
$ 930,893 $ 4,457 $ (133,754) $ 801,596
=========== =========== =========== ===========
$ 1,736,281 $ 18,858 $ (133,996) $ 1,621,143
=========== =========== =========== ===========
Proceeds from sales of available for sale securities were $1,197,281,
$1,763,685 and $1,840,000 for 2003, 2002 and 2001, respectively. Gross
gains of $30,466, $2,161 and $10,031 and gross losses of $74,803,
$32,598 and $6,317 for 2003, 2002 and 2001, respectively, were realized
on those sales. The Company had no significant amount of impaired
investments at December 31, 2003, and believes its investments will be
fully recovered.
For the years ended December 31, 2003, 2002 and 2001, interest income
for available for sale securities was $1,291, $29,066 and $77,618,
respectively. Dividend income for available for sales securities for
the years ended December 31, 2003, 2002 and 2001 was $41,849, $29,437
and $8,443, respectively.
3. PROPERTY AND EQUIPMENT
Property and equipment consists of the following at December 31:
December 31, 2002
-----------------
2003 2002
---- ----
Office furniture, fixtures and equipment ... $ 4,501,628 $ 4,362,068
Vehicles ................................... 923,876 842,081
Leasehold improvements ..................... 62,793 62,793
Building ................................... 1,521,083 1,521,083
Land ....................................... 148,308 148,308
----------- -----------
7,157,688 6,936,333
Accumulated depreciation and amortization .. (3,695,955) (3,030,901)
----------- -----------
Total property and equipment, net .......... $ 3,461,733 $ 3,905,432
=========== ===========
Depreciation expense for the years ended December 31, 2003, 2002 and
2001 was $870,574, $855,570, and $790,115, respectively.
During 2001, the Company completed construction of a state-of-the-art
distribution and call center facility in Oklahoma City. The 23,346
square foot facility has the capability of handling warehouse volumes
of up to $100 million in annual sales, and up to 100 employees in the
call center. The Company funded this project, in part, with bank loans
of $980,000 for the land and building and $166,216 for warehouse
equipment. The interest rate on both loans is the Prime Rate minus
.25%, which was 3.75% as of December 31, 2003, and requires 60 monthly
principal and interest payments of
F-15
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 (CONT.)
$9,570, with the remaining balance due on September 30, 2006. The
balance of both loans, plus accrued interest, was paid in full on
January 14, 2004.
4. DEBT
Notes payable and long-term debt consisted of the following at December
31:
2003 2002
---- ----
Note payable to bank, with interest at prime less .25% (3.75% at
December 31, 2003), payable in monthly installments of principal and
interest, due on September 30, 2006, collateralized by warehouse and
equipment..................................................................... $ 853,270 $ 911,686
Note payable to bank, with interest at prime less .25% (3.75% at
December 31, 2003), payable in monthly installments of principal and
interest, due on September 30, 2006, collateralized by
certain assets................................................................ 145,950 154,630
Note payable to RMS Limited Partnership, 7.5% effective rate, payable in
60 monthly installments net of discount of $80,069 and $169,070 at
December 31, 2003 and 2002, respectively (See Note 10)........................ 961,606 1,372,610
9.0% note payable to Ford Credit, payable in monthly installments of
$720.13....................................................................... -- 5,702
5.0% note payable to Lexus Motor Credit, payable in monthly installments
of $588.59.................................................................... 28,344 --
---------- ----------
1,989,170 2,444,628
Less current maturities...................................................... 485,161 455,296
---------- ----------
$1,504,009 $1,989,332
========== ==========
Interest expense for the year ended December 31, 2003, 2002 and 2001
was approximately $143,000, $167,000 and $199,000. Under the original
terms of the bank notes, the Company was subject to various covenants,
which include minimum tangible net worth, minimum debt service coverage
ratio, and maximum debt to EBITDA ratio requirements.
F-16
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 (CONT.)
Future maturities of long-term debt consists of the following at
December 31, 2003:
2004............................................. $ 485,161
2005............................................. 571,968
2006............................................. 921,933
2007.............................................. 6,710
2008.............................................. 3,398
-----------
$ 1,989,170
===========
All of the notes payable and long-term debt was paid in full in January
2004, using proceeds from the exercise of outstanding warrants.
5. LEASE AGREEMENTS
The Company has various capital leases for office equipment. The lease
terms range from 24 to 60 months. Additionally, annual lease rental
payments for each lease range from $700 to $40,000 per year. The
schedule of future minimum lease payments below reflects all payments
under the leases.
The property and equipment accounts include $846,414 and $718,554 for
leases that have been capitalized at December 31, 2003 and 2002,
respectively. Related accumulated amortization amounted to $570,718 and
$473,109 at December 31, 2003 and 2002, respectively.
The Company leases office space under noncancellable operating leases.
Future annual minimum lease payments under capital leases and
noncancellable operating leases with initial or remaining terms of one
year or more at December 31, 2003 are as follows:
CAPITAL OPERATING
LEASES LEASES TOTAL
------ ------ -----
Year ending:
2004 ......................................... $ 91,831 $132,278 $224,109
2005 ......................................... 75,131 131,887 207,018
2006 ......................................... 25,572 133,999 159,571
2007 ......................................... 25,572 135,041 160,613
2008 ......................................... 26,142 116,645 142,787
-------- -------- --------
Total minimum lease payments ................. $244,248 $649,850 $894,098
======== ========
Less amount representing interest ............ 22,414
--------
Present value of net minimum lease payments .. 221,834
Less current portion ......................... 78,954
--------
Long-term capital lease obligations .......... $142,880
========
Rental expense under operating leases for the years ended December 31,
2003, 2002 and 2001 was $164,346, $202,122, and $202,951, respectively.
6. STOCKHOLDERS' EQUITY
Common Stock - On March 4, 1998, the Company announced its intent to
repurchase up to one million shares of the Company's common stock in
the open market for cash. In connection with such repurchase, the
Company filed with the Securities and Exchange Commission pursuant to
Section 13(e)(1) of the Securities Exchange Act of 1934, as amended, an
Issuer Tender Offer Statement on
F-17
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 (CONT.)
March 4, 1998. As of December 31, 2003, the Company had repurchased
472,795 shares of the common stock at a total cost of $2,244,476.
Common Stock Options and Other Warrants - During 2003, the Company
granted 1,348,151 options to employees at exercise prices ranging from
$1.30 per share to $3.95 per share. Options were granted primarily for
services rendered and to ensure the future availability of those
services to the Company. During 2003, 369,838 prior options were
exercised for cash. In addition, during the period, 43,158 options were
canceled and no options expired.
During 2002, the Company granted 325,982 options to employees at
exercise prices ranging from $1.31 per share to $2.28 per share.
Options were granted primarily for services rendered and to ensure the
future availability of those services to the Company. During 2002,
14,500 prior options were exercised for cash. In addition, during the
period, 97,714 options were canceled and 13,870 options expired.
During 2001, the Company granted 388,694 options to employees at
exercise prices ranging from $2.60 per share to $3.00 per share.
Options were granted primarily for services rendered and to ensure the
future availability of those services to the Company. None of the
options granted during 2001 were exercisable at December 31, 2001 due
to a one year minimum vesting period. During 2001, 61,000 prior options
were exercised for cash. In addition, during the period, 257,976
options were canceled and no options expired.
The following table summarizes the Company's employee stock option and
other warrants activity for the years ended December 31, 2003, 2002 and
2001:
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
2003 PRICE 2002 PRICE 2001 PRICE
---- ----- ---- ----- ---- -----
Options and other
warrants outstanding
beginning of year............ 1,756,653 $ 2.36 1,556,755 $2.54 1,487,037 $2.62
Options and other
warrants issued
during the year............... 1,348,151 1.64 325,982 1.60 388,694 2.71
Options and other
warrants exercised
during the year............... (369,838) 2.18 (14,500) 2.00 (61,000) 2.00
Option and other
warrants cancelled
during the year............... (43,158) 3.04 (97,714) 2.74 (257,976) 3.40
Options and other
warrants expired
during the year............... -- -- (13,870) 2.24 -- --
--------- --------- ---------
Options and other
warrants outstanding,
end of year................... 2,691,808 $ 2.04 1,756,653 $2.36 1,556,755 $2.54
========= ======== ========= ===== ========= =====
F-18
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 (CONT.)
The weighted average grant-date fair value of options and other
warrants granted during 2003, 2002 and 2001 was $1.58, $0.73 and $1.80
per share, respectively.
Options and Other Warrants Options and Other Warrants
Outstanding Exercisable
----------- -----------
WEIGHTED-
AVERAGE WEIGHTED- WEIGHTED-
NUMBER REMAINING AVERAGE NUMBER AVERAGE
RANGE OF OUTSTANDING CONTRACTUAL EXERCISE EXERCISABLE EXERCISE
EXERCISE PRICES AT 12/31/03 LIFE PRICE AT 12/31/03 PRICE
- --------------- ----------- ---- ----- ----------- -----
$1.30 - $2.95 2,391,026 6.20 years $1.79 1,134,879 $1.98
$3.00 - $4.75 251,910 2.20 years $3.68 191,591 $3.70
$5.25 - $6.13 48,872 1.23 years $5.79 42,198 $5.82
--------- ---------
2,691,808 $2.04 1,368,668 $2.34
========= =========
Common Stock Warrants - The following table summarizes the Company's
common stock warrants and their activity for the years ended December
31, 2003, 2002 and 2001:
WARRANTS
ISSUED AND EXERCISE
OUTSTANDING PRICE EXERCISE PERIOD
----------- ----- ---------------
December 31, 2003:
1997-A Warrants, beginning of the year ...................... 308,768 $3.40 1/31/97-11/06/04
1997-A Warrants, exercised during the year .................. 5,453 $3.40
---------
1997-A Warrants, end of the year ............................ 303,315 $3.40
=========
Redeemable Common Stock Purchase
Warrants, beginning of the year ............................. 1,436,000 $3.40 11/06/97-11/06/04
Redeemable Common Stock Purchase
Warrants, exercised during the year ......................... 422,202 $3.40
---------
Redeemable Common Stock Purchase
Warrants, end of the year ................................... 1,013,798 $3.40
=========
Underwriters' Warrants, beginning of the year ............... 130,000 $5.40 11/12/98-11/12/04
Underwriters' Warrants, exercised during the year ........... 94,040 $5.40
---------
Underwriters' Warrants, end of the year ..................... 35,960 $5.40
=========
December 31, 2002
1997-A Warrants ............................................. 308,768 $3.40 1/31/97-11/06/03
=========
Redeemable Common Stock Purchase
Warrants .................................................... 1,436,000 $3.40 11/06/97-11/06/03
=========
Underwriters' Warrants ...................................... 130,000 $5.40 11/12/98-11/12/03
=========
December 31, 2001:
1997-A Warrants. ............................................ 308,768 $3.40 1/31/97-11/06/02
=========
Redeemable Common Stock Purchase
Warrants .................................................... 1,436,000 $3.40 11/06/97-11/06/02
=========
Underwriters' Warrants ...................................... 130,000 $5.40 11/12/98-11/12/02
=========
Each warrant entitles the holder to purchase one share of common stock.
As of January 8, 1998, the Company reduced the exercise price of the
1997-A Warrants from $12.00 to $3.40 and extended the exercise period
from January 31, 1999 to November 6, 2002, to correspond more closely
to the terms of the Redeemable Common Stock Purchase Warrants. In
addition, on September 16, 2002 the Company
F-19
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 (CONT.)
extended the exercise period from November 6, 2002 November 12, 2003.
On October 14, 2003, the Company extended the exercise period for the
1997-A warrants from November 12, 2003 to November 12, 2004. On
December 10, 2003, the Company announced the redemption of all
outstanding 1997-A warrants not exercised by January 16, 2004. Proceeds
from the 1997-A warrant redemption totaled $714,877 and payment for
unexercised warrants was $25.
As of January 6, 1998, the exercise price of the Redeemable Common
Stock Purchase Warrants was adjusted from $5.40 to $3.40. In addition,
on September 16, 2002 the Company extended the exercise period from
November 6, 2002 to November 12, 2003. On October 14, 2003, the Company
extended the exercise period for the redeemable stock purchase warrants
and the underwriter warrants from November 12, 2003 to November 12,
2004. On December 10, 2003, the Company announced the redemption of all
outstanding redeemable stock purchase warrants and the underwriter
warrants not exercised by January 16, 2004. Proceeds from the
redeemable stock purchase warrants and the underwriter warrant
redemption totaled $5,394,615 and payment for unexercised warrants was
$11,870.
There was no expense recognized in the Company's financial statements
relating to either of the warrant exercise price reductions as the
changes only affected allocations of additional paid-in capital because
the Redeemable Common Stock Purchase Warrants and the 1997-A Warrants
were issued in conjunction with an equity offering of the Company. The
reduced exercise prices exceeded the market value of the Company's
common stock on the date of the reduction. In addition, there was no
expense recognized in the Company's financial statements relating to
the extension of the exercise period for either the 1997-A Warrants or
the Redeemable Common Stock Purchase Warrants.
The Redeemable Common Stock Purchase Warrants are subject to redemption
by the Company at $0.25 per warrant. All of the outstanding Redeemable
Common Stock Purchase Warrants must be redeemed if any are redeemed.
The Company may redeem the 1997-A Warrants for $0.0001 per warrant. Any
redemption of unexercised 1997-A Warrants would be for all such
outstanding warrants. The Underwriters' Warrants were issued in
connection with the sale of common stock and Redeemable Warrants in
November 1997 and were in addition to other fees paid to the
underwriters. The Underwriters' Warrants entitle the holder to purchase
one unit consisting of one share of the Company's common stock and one
Redeemable Common Stock Purchase Warrant.
7. STOCK OPTION PLANS
During 1995, the Company approved the 1995 Stock Option Plan (the
"Plan"). Under this Plan, options available for grant can consist of
(i) nonqualified stock options, (ii) nonqualified stock options with
stock appreciation rights attached, (iii) incentive stock options, and
(iv) incentive stock options with stock appreciation rights attached.
The Company has reserved 1,125,000 shares of the Company's common stock
$.0001 par value, for the Plan. The Plan limits participation to
employees, independent contractors, and consultants. Non-employee
directors are excluded from Plan participation. The option price for
shares of stock subject to this Plan is set by the Stock Option
Committee of the Board of Directors at a price not less than 85% of the
market value of the stock on the date of grant. No stock options may be
exercised within six months from the date of grant, unless under a Plan
exception, nor more than ten years after the date of grant. The Plan
provides for the grant of stock appreciation rights, which allow the
holder to receive in cash, stock or combination thereof, the difference
between the exercise price and the fair value of the stock at date of
exercise. The fair value of stock appreciation rights is charged to
compensation expense. The stock appreciation right is not separable
from the underlying stock option or incentive stock option originally
granted and can only be exercised in tandem with the stock option. No
stock appreciation rights are attached to any options outstanding.
F-20
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 (CONT.)
During 2003, the Company approved the 2003 Stock Incentive Plan, or
2003 Plan. Under the 2003 Plan, options available for grant can consist
of (i) nonqualified stock options, (ii) incentive stock options, and
(iii) restricted stock. The Company has reserved 2,000,000 shares of
the Company's common stock $.0001 par value for the 2003 Plan. The Plan
limits participation to employees, independent contractors, and
consultants. The option price for shares of stock subject to this Plan
is set by the Compensation Committee of the Board of Directors at a
price not less than market value of the common stock on the date of
grant. No stock options may be exercised within six months from the
date of grant, unless under a Plan exception, nor more than ten years
after the date of grant.
During the year ended December 31, 2003, the Company issued no options
under the 1995 Plan and 1,334,000 options under the 2003 Plan. During
the year ended December 31, 2002 the Company issued 325,982 options
under the 1995 Plan. At December 31, 2003, the Company had 2,691,807
stock options outstanding of which 932,807 were issued pursuant to the
1995 Plan and 1,329,000 were issued pursuant to the 2003 Plan. During
the year ended December 31, 2002, the Company had 1,756,653 stock
options outstanding of which 1,083,403 were issued pursuant to the 1995
Plan.
8. RELATED PARTIES
During 2003, 2002 and 2001, the Company received approximately $8,520,
$7,069 and $15,231, respectively, from Pre-Paid Legal Services, Inc.
("Pre-Paid Legal"), a shareholder, for commissions on sales of
memberships for the services provided by Pre-Paid Legal. As of July 1,
2000, the Company began offering the Company's employees access to the
services provided by Pre-Paid Legal through an employee benefit option.
The Company pays half of the cost for each employee electing to
participate in the plan. During 2003, 2002 and 2001, the Company paid
$5,532, $6,934 and $7,593, respectively, to Pre-Paid Legal for these
services. The Company's Chairman of the Board and Chief Executive
Officer, John W. Hail, is a director of Pre-Paid Legal.
During the first quarter of 1998, the Company agreed to loan John W.
Hail up to $250,000. Subsequently the Company also agreed to loan up to
an additional $75,000. In 2000, an additional $200,000 was approved. On
January 1, 2001 the outstanding balance on all the notes were combined
into one note payable in monthly installments. The loans and extension
were unanimously approved by the board of directors. These loans were
collateralized by stock and property, and bear interest at 8% per
annum. These loans were fully paid in 2003.
Also during 2003, 2002 and 2001, the Company paid Mr. Loney and his
wife sales bonuses of $25,460, $30,887 and $38,028, respectively. These
bonuses were based upon purchases by them and their downline associates
in accordance with the Company's network marketing program applicable
to all independent associates in effect at the time of the sales. Mr.
Loney's wife is the daughter of John W. Hail.
F-21
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 (CONT.)
9. INCOME TAXES
Income taxes for 2003, 2002 and 2001 are comprised of current tax
(benefit) expense of $0, $(423,279) and $(37,722) and deferred taxes of
$(1,031,839), $(1,331,778) and $43,189, respectively. A reconciliation
of the statutory Federal income tax rate to the effective income tax
rate for the years ended December 31, 2003, 2002, and 2001 is as
follows:
2003 2002 2001
---- ---- ----
Statutory federal income tax rate .. (34.0)% (34.0)% 34.0%
State tax effective rate ........... (4.0) (4.0) 4.0
Permanent differences .............. 7.5 2.1 2.1
Benefit of graduated tax rates ..... 0.2 0.2 -
Prior year assessments finalized ... (2.4) - (1.5)
Increase in valuation allowance..... 14.0 - -
Other .............................. - 0.3 0.4
----- ----- ----
(18.7)% (35.4)% 39.0%
===== ===== ====
The change in the total deferred tax net assets from December 31, 2002
to December 31, 2003 was $482,355. This difference is allocated as
$590,839 included in tax expense reduced by $108,484 classified in
stockholders' equity, respectively.
Deferred tax liabilities and assets at December 31, 2003 and 2002 are
comprised of the following:
December 31,
------------
2003 2002
---- ----
Deferred tax liabilities:
Depreciation ...................................... $ (212,959) $ (178,789)
Unrealized gains .................................. (56,646)
----------- -----------
Total deferred tax liabilities .................. (269,605) (178,789)
----------- -----------
Deferred tax assets:
Goodwill impairment and other intangibles ......... 1,170,825 1,273,415
Net operating loss carryforwards .................. 1,069,391 151,371
Deferred compensation ............................. 252,074 -
Inventory ......................................... 41,471 60,518
Unrealized losses ................................. - 43,448
Other ............................................. 64,870 47,239
Valuation allowance ............................... (441,000) -
----------- -----------
Total deferred tax assets ....................... 2,157,631 1,575,991
----------- -----------
Net deferred taxes ................................. 1,888,026 1,397,202
Less current portion of net deferred tax assets .... 4,854 120,343
----------- -----------
Noncurrent portion of deferred tax asset ........... $ 1,883,172 $ 1,276,859
=========== ===========
The valuation allowance increased $441,000 for the year ended December
31, 2003.
On a regular basis, management evaluates all available evidence, both
positive and negative, regarding the ultimate realization of the tax
benefits of its deferred tax assets. Valuation allowances have been
established for certain operating loss and credit carryforwards that
reduce deferred tax assets to an amount that will, more likely than
not, be realized. Uncertainties that may affect the realization of
these assets include tax law changes and the future level of product
prices and costs. The outlook for determination of this allowance is
calculated on the Company's historical taxable income, its expectations
for the future based on a rolling twelve quarters, and available
tax-planning strategies. Based on this determination, management
expects that the net deferred tax assets will be realized as offsets to
reversing deferred tax liabilities and as offsets to the tax
consequences of future taxable income. The Company has net operating
loss carryforwards of $2,834,000 available to reduce future taxable
income, which will begin to expire in 2009. Net operating loss
carryforwards of $196,000 are limited in usage.
10. ACQUISITIONS
On January 4, 2001, the Company and one of its wholly owned
subsidiaries, LifeScience Technologies Holdings, acquired LifeScience
Technologies Holding Limited Partnership, LifeScience Technologies
F-22
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 (CONT.)
Limited, LifeScience Technologies of Japan, LST Fulfillment limited
Partnership and LifeScience Technologies of Canada, Inc. (the
"LifeScience Technologies Acquisition"). The purchase price to the
Company was approximately $1.2 million cash plus $41,667 per month or
5% of LifeScience Technology product sales, whichever is greater,
payable for 60 months commencing in January 2001. The seller, at its
option, has the right to take shares of the Company's common stock at
an option price of $3.00 per share in lieu of cash for the monthly
payment. However, such option is limited to a total of 860,000 shares
and shares not taken in a month are not cumulative. No shares have been
issued under the agreement at December 31, 2003. In addition, the
balance of the acquisition price, plus accrued interest, was paid in
full on January 29, 2004.
The estimated fair value of assets acquired and liabilities assumed at
acquisition are as follows:
Estimated Fair value of assets
Cash ................................ $ 76,760
Inventory ........................... 793,629
Property and equipment .............. 283,924
Goodwill and other intangibles ...... 2,508,805
----------
Total fair value of assets ........ 3,663,118
Liabilities assumed
Accounts payable .................... 176,060
Accounts expenses ................... 181,223
----------
Estimated fair value of acquisition $3,305,835
==========
The LifeScience Technologies Acquisition was accounted for as a
purchase under Accounting Principles Board Opinion No. 16 ("APB No.
16"). In accordance with APB No. 16, the company allocated the purchase
price of the LifeScience Technologies acquisition based on the fair
value of the assets acquired and liabilities assumed.
11. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Year Ended December 31,
-----------------------
2003 2002 2001
---- ---- ----
Cash paid during the year for:
Interest $ 140,232 $ 194,386 $ 198,740
Income taxes - net of refund. -- (56,912) (288,598)
Noncash financing and investing activities:
Property and equipment acquired by capital lease 131,807 -- 92,202
Note payable for purchase of vehicle 31,128
LifeScience Technologies Acquisition:
Fair value of tangible net assets acquired $ -- $ -- $ 797,030
Purchase price in excess of tangible net assets
acquired -- -- 2,508,805
Present value of future payments required -- -- (2,079,439)
Cash included in tangible net assets acquired -- -- (76,760)
--------- --------- ----------
Cash paid for acquisition, net of cash acquired $ -- $ -- $1,149,636
========= ========= ==========
F-23
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 (CONT.)
12. COMMITMENTS, CONTINGENCIES AND GUARANTEES
RECENT REGULATORY DEVELOPMENTS - As a marketer of products that are
ingested by consumers, the Company is subject to the risk that one or
more of the ingredients in its products may become the subject of
adverse regulatory action. On February 11, 2004, the Food and Drug
Administration, or FDA, issued and published in the Federal Register
its Final Rule on Ephedrine-containing Supplements, stating that since
an "unreasonable risk" had been determined, such supplements would be
considered "adulterated" under the Federal Food, Drug and Cosmetic Act,
or FFDCA, and thus may not be sold. In essence, this Final Rule (or
regulation) imposes a national ban on ephedrine supplements.
The effective date of this regulation is April 12, 2004. The Company
will comply and cease all sales and advertisement of AM-300 and any
other ephedra-containing supplement on April 12, 2004. The FDA has
indicated that it will now consider whether alternatives to Ephedra and
other weight loss and energy stimulants (such as bitter orange)
similarly carry an unreasonable risk. These proposals to limit
stimulant ingredients, if finalized, may necessitate reformulations of
some of the Company's weight loss products.
Finally, as the press, the FDA, and members of Congress and of the
supplement industry have all predicted, the very issuance of the Final
Rule on Ephedra may cause Congress to rethink and amend The Dietary
Supplement Health and Education Act of 1994, or DSHEA, as to how safety
in supplements may be ensured. In particular, there is growing
sentiment (including from one herbal trade association) to make Adverse
Event Reporting mandatory for all manufacturers and marketers of
dietary supplements, so that FDA may take action more quickly than it
did on Ephedra, when a harmful herb or other ingredient is suspected.
Again, the Company's regulatory counsel will keep it apprised of any
challenges to DSHEA, especially any proposed bills that would amend
this Act.
The Texas Department of Health promulgated a new regulation, which
became effective on January 1, 2001. The regulation requires a warning
to appear on the product label indicating that the sale of
ephedra-containing products to minors is illegal. The Company's AM-300
labels comply with this regulation. Again, after April 12, 2004 no
sales of ephedrine-containing supplements are allowed nationally, and
thus state regulations such as this are superceded and moot.
Manufacturing. On March 13, 2003, the FDA published a proposed rule in
the Federal Register which proposes comprehensive requirements for the
manufacturing, packing and holding dietary supplements, also known as
good manufacturing practices, or GMPs. The FDA accepted public comments
on the proposed GMPs until June 11, 2003; final GMPs will be
promulgated after the FDA has reviewed the public comments. Once final
GMP regulations become effective, the Company's manufacturer will be
required to adhere to them. The FDA will most likely institute an
effective date for the GMPs which will allow the Company's manufacturer
a reasonable amount of time to conduct this review and, if necessary,
revise its manufacturing operations to comply with the final GMP
regulations.
Advertising and Website. The FDA considers website promotional content
to constitute "labeling," and thus the Company's website must not
contain disease claims or drug claims, but only permissible
structure/function claims. The Federal Trade Commission, or FTC,
governs the advertising of dietary supplements, in any medium or
vehicle--print ads, radio spots, infomercials, etc.--including on
Internet ads and websites. The fundamental FTC rule is that all
material advertising claims, whether express (direct) or implied, must
be substantiated by reliable and competent scientific evidence. Because
the Company's website must
F-24
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 (CONT.)
comply with both FDA and FTC regulations, management routinely asks its
regulatory compliance counsel to review certain web pages, especially
the content of new product promotions. When necessary, the Company's
regulatory counsel also reviews the scientific substantiation for
particular claims (again, especially for new products such as Prime
One, an anti-stress and weight loss product) to determine if it is
sufficient, and also that there are no disease claims present, the main
FDA issue. Any major website revision will be reviewed by counsel.
Finally, the Company wanted to address a potential liability or
exposure problem stemming from some of its independent associates
creating their own websites, which had not been subject to regulatory
review. The Company was concerned that these "renegade" websites could
contain impermissible disease claims as to dietary supplements, or
false, unsubstantiated or misleading promotional claims in violation of
the FTC. The solution, proposed and drafted by the Company's regulatory
counsel, was that on February 24, 2004, the Company sent a notice to
associates clearly stating that the policy of the Company is to be in
full compliance with all applicable FDA and FTC regulations, and that
to ensure Internet compliance, associates should simply copy or link to
the corporate website. This Policy letter further stated that any
independent websites were absolutely unauthorized, and their creators
would be solely liable for defending any regulatory enforcement
actions.
The Company, like other marketers of products that are intended to be
ingested, faces an inherent risk of exposure to product liability
claims in the event that the use of its products results in injury. The
Company maintains a claims made policy, with limited liability
insurance coverage. The limits of this coverage are $1,000,000 per
occurrence and $2,000,000 in the aggregate. Products containing
ephedra, which represented approximately 35.9% of the Company's 2003
net revenue, are not covered by the Company's product liability
insurance. The Company generally does not obtain contractual
indemnification from parties manufacturing its products. However, all
of the manufacturers of the Company's products carry product liability
insurance, which covers the Company's products. Although the Company
has never had a product liability claim, such claims against the
Company could result in material losses to the Company.
LEGAL PROCEEDINGS - The Company is currently involved in five products
liability suits related to the ingestion of its ephedra-based products.
Answers to these petitions have been or soon will be filed, and written
discovery and responses have been or soon will be exchanged. The
Company has denied, and will continue to deny, any wrongdoing and
intends to vigorously defend against the claims. The amounts of damages
sought are unknown, but include compensatory and punitive damages.
13. DEFERRED COMPENSATION
On November 4, 2003 the Company entered into a written employment
agreement with John W. Hail, Chief Executive Officer, or the Executive.
The contract is for an initial two-year term, commencing November 4,
2003, and may be extended for up to five successive one-year terms if
the Company and the Executive agree in writing. The contract calls for
a base salary of $249,600 per year, a monthly bonus payment of one
percent (1%) of the Company's gross revenues, and a discretionary
year-end bonus determined by a majority vote of the Board of Directors.
The agreement also contains provisions for graduated severance payments
if the Company terminates the Executive without cause. In addition, if
the employment period is extended beyond November 11, 2005, the monthly
bonus payment will cease and be replaced by a fixed supplemental
payment to the Executive, which will be in a gross amount necessary to
cover all federal, state and local taxes and all employment taxes, and
pay a net amount of $7,000 per month. At December 31, 2003, the
discounted value of those fixed supplemental payments was approximately
$668,000. The Company accrued this expense as distribution and
administrative expenses.
14. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a summary of the quarterly results of operations for
the years ended December 31, 2003 and 2002.
F-25
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 (CONT.)
2003
-----------------------------------------------------------
December 31 September 30 June 30 March 31
----------- ------------ ------- --------
Revenues .............. $ 4,302,185 $ 4,883,055 $ 4,686,784 $ 4,614,153
Costs and expenses .... 6,421,667 5,193,596 4,972,625 5,057,989
----------- ----------- ----------- -----------
Income (loss) before
income taxes ........ (2,119,482) (310,541) (285,841) (443,836)
Income tax expense
(benefit) ............ (185,033) (121,232) (111,478) (173,096)
----------- ----------- ----------- -----------
Net income (loss) .... $(1,934,449) $ (189,309) $ (174,363) $ (270,740)
=========== =========== =========== ===========
Net income (loss) per
common share -
basic ................ $ (0.41) $ (0.04) $ (0.04) $ (0.06)
=========== =========== =========== ===========
Net income (loss) per
common share -
assuming dilution .... $ (0.41) $ (0.04) $ (0.04) $ (0.06)
=========== =========== =========== ===========
Net Loss per share is computed independently for each of the quarters
presented; therefore, the sum of the quarterly loss per share does not
necessarily equal the total for the year.
2002
----------------------------------------------------------
December 31 September 30 June 30 March 31
----------- ------------ ------- --------
Revenues .............. $ 4,630,657 $ 5,525,701 $ 5,865,850 $ 6,281,373
Costs and expenses .... 9,547,803 5,845,558 5,738,921 6,131,391
----------- ----------- ----------- -----------
Income (loss) before
income taxes ........ (4,917,146) (319,857) 126,929 149,982
Income tax expense
(benefit) ............ (1,738,308) (124,744) 49,502 58,493
----------- ----------- ----------- -----------
Net income (loss) .... $(3,178,838) $ (195,113) $ 77,427 $ 91,489
=========== =========== =========== ===========
Net income (loss) per
common share -
basic ................ $ (0.73) $ (0.04) $ 0.02 $ 0.02
=========== =========== =========== ===========
Net income (loss) per
common share -
assuming dilution .... $ (0.73) $ (0.04) $ 0.02 $ 0.02
=========== =========== =========== ===========
Net Income (loss) per share is computed independently for each of the
quarters presented; therefore, the sum of the quarterly income (loss)
per share does not necessarily equal the total for the year.
F-26
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 (CONT.)
15. YEAR-END ADJUSTMENTS
The Company made certain year-end adjustments in 2003 resulting from
the write off of bad debts, the write down of fixed assets, and accrual
of deferred compensation that were material to the results of the
fourth quarter. These adjustments, after applicable income tax effects,
reduced net income (loss) as follows:
Write off of bad debts................................. $ 24,500
Write down of fixed assets............................. 66,500
--------
$ 91,000
========
These adjustments increased 2003 fourth quarter basic loss per share by
$0.02.
16. VALUATION AND QUALIFYING ACCOUNTS
The table below shows the beginning balance, activity and ending
balance for the Company's reserves and allowances deducted from asset
accounts:
Additions
-----------------------
Balance at Charged to Charged to
Beginning of Costs and Other Balance at
Description Period Expenses Accounts Deductions End of Period
- -----------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 2003:
Reserves and allowances deducted
from asset accounts:
Allowance for doubtful accounts $ -- $-- $ --
Allowance for obsolete inventory 116,143 116,143 --
Allowance for deferred tax assets -- 441,000 441,000
YEAR ENDED DECEMBER 31, 2002:
Reserves and allowances deducted
from asset accounts:
Allowance for doubtful accounts $ 92,931 $ 92,931 $ --
Allowance for obsolete inventory -- 116,143 116,143
YEAR ENDED DECEMBER 31, 2001:
Reserves and allowances deducted
from asset accounts:
Allowance for doubtful accounts $ 157,804 $ 64,873 $ 92,931
Allowance for obsolete inventory -- -- --
* * * * * *
F-27
Exhibit Index
3.1 The Registrant's Certificate of Incorporation, incorporated by
reference to the Registration Statement on Form SB-2
(Registration No. 333-47801) filed with the commission on
March 11, 1998.
3.2 The Registrant's Bylaws, incorporated by reference to the
Registration Statement on Form SB-2 (Registration No.
333-47801) filed with the commission on March 11, 1998.
10.1 Warrant Agreement between Registrant and U.S. Stock Transfer
Inc., dated as of January 16, 1997, as amended and restated
January 8, 1998, incorporated by reference to Amendment No. 2
to Form 8-A Registration Statement, filed with the Commission
on January 13, 1998.
10.2 Unit and Warrant Agreement between Registrant and U.S. Stock
Transfer Inc., dated as of November 6, 1997, as amended and
restated January 8, 1998, incorporated by reference to
Amendment No. 1 to Form 8-A Registration Statement, filed with
the Commission on January 15, 1998.
10.5 Purchase and Assignment Agreement by and among Advantage
Marketing Systems, Inc., LifeScience Technologies Holdings,
Inc., GHI Holdings, Inc., LifeScience Technologies, Inc. and
RMS Limited Partnership, dated as of January 3, 2001,
incorporated by reference to Form 8-K filed with the
Commission on January 8, 2001.
10.6 Promissory Note dated January 3, 2001, to RMS Limited
Partnership by Advantage Marketing Systems, Inc., LifeScience
Technologies Holdings, Inc., LifeScience Technologies Holdings
Limited Partnership, LifeScience Technologies Holdings, Inc.,
LifeScience Technologies of Japan and LST Fulfillment Limited
Partnership, incorporated by reference to Form 8-K filed with
the Commission on January 8, 2001.
10.7 Stock Option Agreement of Advantage Marketing Systems dated
January 3, 2001, incorporated by reference to Form 8-K filed
with the Commission on January 8, 2001.
10.8 Joint Marketing Agreement with PrimeBuy Network.com, Inc.,
dated August 30, 2002, incorporated by reference to Form 10-Q
filed with the Commission on November 1, 2002.
10.9 Promissory Note executed by PrimeBuy Network.com, Inc., dated
August 2, 2002, incorporated by reference to Form 10-Q filed
with the Commission on November 1, 2002.
10.10* The Advantage Marketing Systems, Inc. 1995 Stock Option
Plan, incorporated by reference to Form SB-2 Registration
Statement (No. 33-80629), filed with the Commission on
November 20, 1996.
10.11* Employment Agreement by and between David D'Arcangelo and
Registrant dated effective as of November 25, 2002,
incorporated by reference to Form 10-K/A filed with the
Commission on March 31, 2003.
10.12* Non-Qualified Stock Option Agreement by and between David
D'Arcangelo and Registrant dated effective as of December 2,
2002, incorporated by reference to Form 10-K/A filed with the
Commission on March 31, 2003.
10.13* The Advantage Marketing Systems, Inc. 2003 Stock Incentive
Plan, incorporated by reference to Form S-8 Registration
Statement (No. 333-109093), filed with the Commission on
September 24, 2003.
10.14 Fulfillment Services Agreement with Vita Sales & Distribution
Multi-Country, dated January 19, 2004, filed herewith.
10.15* Employment Agreement by and between John W. Hail and
Registrant dated effective as of November 4, 2003, filed
herewith.
21 Subsidiaries, incorporated by reference to Form 10-K filed
with the Commission on April 17, 2001.
23.1 Consent of Grant Thornton LLP, filed herewith.
31.1 Rule 13a-14(a) Certification by our Chairman and Chief
Executive Officer, filed herewith.
31.2 Rule 13a-14(a) Certification by our Chief Financial Officer,
filed herewith.
32.1 Section 1350 Certification of our Chief Executive Officer,
filed herewith.
32.2 Section 1350 Certification of our Chief Financial Officer,
filed herewith.
* Designates a compensatory plan.